Your index fund costs more than you think

If you're an index fund investor, you've likely looked at fees before.

The main fee, known as the OCF, is usually listed as a percentage (e.g. 0.22%) on the page of the fund you're looking at.

But interestingly, your actual costs can be significantly higher than the amount displayed.

Things to know before we start

We'll be using Vanguard funds as examples in this article, but the types of fees we'll discuss will apply to almost every fund and fund provider out there.

We're not talking about platform fees – the costs to hold an account or trade on a platform.

Vanguard's 0.15% account fee (minimum £4 per month, capped at £375 per year) isn't included here, and is an additional fee on top of the fees we're outlining here.

We'll be using two global index funds as our examples today:

• Vanguard FTSE All-World UCITS ETF (VWRP)
• Vanguard FTSE Global All Cap Index Fund (VAFTGAG)

These are not investment recommendations.

The first is an ETF, the second is a mutual fund.

You don't need to understand what these funds do to follow along with what we're breaking down.

What you'll really pay

You've hopefully heard of OCF (Ongoing Charges Figure) or TER (Total Expense Ratio). You'll usually see this figure listed on a fund's page along with a note: transaction costs apply.

OCF is the standardised fee used in the UK and EU, and summarises the annual costs of running a fund. It can be any amount but is usually (not always) less than 1% – 0.15%, 0.22%, 0.65%, etc.

But importantly, OCF is just one of four types of fee that can apply to your fund.

Different types of transaction costs account for two of the other charges.

And you can actually see all four fee types listed and broken down inside your annual cost and charges statement – or at least you can with Vanguard.

One-off fees

'One-off' fees apply to ETFs, and include the bid-offer spread on any trades you've made – specifically when you buy or sell an investment.

On the annual report we have access to, the one-off fee is listed at 0.10% but it's an estimate based on a 30-day rolling average per fund. Your rate will likely differ.

This isn't charged by the fund provider (Vanguard in this example) – it's set by market makers on the exchange and reflects supply and demand.

This fee does not apply to Vanguard's mutual funds because they trade with a set buy and sell price, with no spread.

Vanguard's FTSE All-World ETF (VWRP) has an OCF of 0.22%, whereas the Vanguard FTSE Global All Cap Index Fund (VAFTGAG) has a slightly higher OCF at 0.23% – but could the mutual fund work out cheaper because of this?

Let's keep digging.

Ongoing fees

'On-going' (as it's listed on the Vanguard annual statement) refers to the OCF that we discussed above.

It's listed at 0.22% on VWRP and 0.23% on VAFTGAG within the annual statement, which matches the advertised rates.

The OCF is the only pre-determined fee in this list – you know exactly what you'll pay in advance.

Transactional fees

'Transactional' fees refer to spread costs, taxes, and other fees that occur when maintaining and rebalancing a fund.

This is similar to one-off fees, but isn't based on your own trading activity – it's based on the fund's trading activity, to keep weightings balanced and in line with the underlying index.

This applies to both ETFs and mutual funds.

It's listed at 0.03% for VWRP (ETF) and 0.10% for VAFTGAG (mutual fund) on the annual statement we're looking at. Again, your fees will likely vary.

These figures differ from what's listed in Vanguard's most recent full costs and charges document, with both funds showing as less expensive inside said report (at 0.02% and 0.08% respectively).

Incidental fees

'Incidental' fees can include carried interest or performance-related charges; incentives for the fund to do well.

Vanguard does not charge incidental fees on any of their funds at this time.

Their charges document states that they "currently do not have any incidental costs (for example performance fees)".

Similar wording is also used for one-off costs on mutual funds: "currently Vanguard mutual funds do not incur one-off costs."

We're not going to speculate that this wording means things will change in future, but it obviously keeps the door open for additional fees to be introduced down the line. It's also worth noting that they've used this wording for years, and haven't added any of these fees so far.

Total fees

This is the combined total from the four fee types we've just covered.

And you can see them as a percentage within your annual statement.

Actual fees paid, based on the statement we have access to, came in at:

• 0.35% for the FTSE All-World ETF (VWRP)
• 0.33% for the FTSE Global All Cap Index Fund (VAFTGAG)

As a reminder, the OCF for these funds stand at 0.22% and 0.23%, and the fees you pay will likely differ to these.

This isn't a guarantee that the ETF will be more expensive going forward – Vanguard's own data has the total costs coming in at 0.28% and 0.31% respectively, with the ETF winning out on cost.

So what's the verdict? Both are more expensive than you might have thought, but we don't know which one is actually cheaper. We tried.

How this affects forecasts

Think these tiny differences don't add up? You might be massively mistaken – but there's a big (and important) caveat. We'll get to that.

First, try running some calculations using the 'Advanced' mode of our compounding calculator, and use the 'Info view' for results.

Here's one example we'll share: comparing 0.22% and 0.35% in fund management fees.

If we put away £300 per month, increased our deposit by 2% each year, and aimed for an 8% average annual return for 35 years…

• At 0.22%, we pay £16,579 in fund management fees and the impact on our portfolio is £38,086.
• At 0.35%, we pay £25,836 in fund management fees and the impact on our portfolio is £59,601.

That's a difference of around £21,600 in retirement – more than just a few piña coladas when you're on the beach.

Unfortunately, you can't really avoid this reality.

But you can be more aware of it.

You need to be factoring fees into your forecasts in the first place, which many people aren't doing. This is possible with our calculator (using 'Advanced' mode).

But also: you probably need to estimate that you'll be paying more in fees than you might have initially thought.

There's no general rule of thumb you can use to estimate this because the more niche a fund is, the higher the additional costs might be.

There are some transaction costs as high as 0.40% in Vanguard's data – this is for their Global Emerging Markets funds – in addition to a 0.78% OCF.

If we plug these figures in to our calculator, and also factor in Vanguard's platform charges, the estimated total impact of fees on the example portfolio would be a monstrous £197,973.

That's a retirement-defining figure, even after being adjusted for inflation.

The caveat

There's an important distinction to make to explain how these higher fees can affect your forecasted returns.

So, when would you be affected?

Well, you might have heard commonly-shared statistics like "the S&P 500 has delivered an average annual return of 10% long-term."

Importantly, this 10% figure is pre-fees. You can't invest into the S&P 500 index itself, you have to invest into a fund that tracks the index. This fund requires managing, and therefore fees apply.

If you aimed to capture that 10% figure going forward – remembering that past performance isn't a reliable indicator of future results – you would have to also factor in fund fees, platform fees, trading fees, and so on.

Please note: this is a simplified example. Some funds tracking the S&P 500 have still delivered ~10% annualised returns, even after fees – but that’s because the underlying index returned even more. Your capital is always at risk when investing, 10% is generally considered to be an unrealistically high expectation going forward.

But when wouldn't you be affected?

If you were looking at a specific fund – not just an underlying index – and you saw that it had delivered an 8% average annual return. In this example, the results of funds are displayed net of fees. This means fees are already taken into account when looking at the result.

If you expect it to continue delivering those returns going forward, you wouldn't need to forecast with the OCF and additional fund-related costs factored in. You'd only need to include fees like account charges, trading costs, taxes – the stuff that the fund doesn't handle for you, or is charged by the platform or broker you use regardless of the fund you invest into.

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