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Investing Costs: Are They Higher Now Than 10 Years Ago?

Understanding Investment Costs

• The speaker discusses whether investing is more expensive now compared to ten years ago, highlighting that many costs are not explicitly visible to investors.

• A common misconception is that investing in funds incurs no fees; this belief stems from the invisibility of certain charges, particularly management fees.

• The podcast aims to explore various investment-related commissions, including those associated with funds, brokers, and ETFs.

Guest Introduction: Luis Ángel Hernández

• Luis Ángel Hernández introduces himself as a financial educator who founded "Salud Financiera" two years prior and has extensive experience in financial communication.

• He shares his background in law from the University of Valencia and his passion for stock markets and investment funds developed outside formal education.

Current Investment Landscape

• When asked if investing is more expensive now than a decade ago, Luis Ángel asserts that it is actually cheaper today due to increased options available.

• Despite lower costs overall, most investors still choose high-cost products; awareness of cheaper alternatives is growing but remains limited among the general public.

Awareness of Investment Fees

• Luis Ángel estimates that less than 5% of investors accurately understand their investment costs and associated commissions.

• Many believe they incur no fees because these costs are deducted daily without explicit notification, leading to misconceptions about the nature of fund investments.

Breakdown of Common Commissions

• The discussion transitions into specific types of commissions involved in typical investment funds.

• The most significant fee discussed is the management fee, which covers operational costs such as salaries and distribution expenses but often goes unnoticed by investors.

• Another fee mentioned is the custody or deposit fee charged by third-party banks responsible for holding assets when a fund manager does not directly manage them.

Understanding Investment Fees and Commissions

Types of Investment Costs

• Investors often overlook various commissions that can significantly impact their returns, including hidden fees that may not be immediately apparent.

• Transaction costs are incurred by fund managers when buying stocks or bonds, which can vary based on the complexity of the investment. These costs are separate from management fees.

• Additional expenses such as audit fees and registration costs with regulatory bodies exist but are generally less variable compared to transaction costs.

Active vs. Passive Management Costs

• The cost structure differs between active and passive fund management; a stable portfolio incurs lower transaction costs than an actively managed one that frequently trades assets.

• In traditional banking practices, funds investing in other funds (fund-of-funds) create a cascade of fees where investors pay multiple layers of management fees.

Performance-Based Fees

• Success fees reward fund managers for achieving positive results, typically calculated as a percentage of profits above a benchmark index or target return.

• There is confusion among investors regarding success fees; they apply only to gains made over the initial investment amount, not the total value of the fund.

Implications of Success Fees

• Some funds charge high success fees (up to 20%), leading to potential double charges if performance fluctuates over time without surpassing previous highs.

• The concept known as "watermark reset" allows managers to charge success fees even after periods of loss, which many investors find unfair or confusing.

Industry Perspectives on Fee Structures

• The lack of transparency around success fees leads some investors to avoid these funds altogether due to perceived inequities in fee structures.

• There is ongoing debate within the industry about whether performance-based compensation aligns manager incentives with investor interests effectively.

Understanding Fund Management Fees

The Complexity of Success Fees

• The speaker expresses discomfort with annual success fees, particularly when a flat fee is charged regardless of performance. They argue that this creates an imbalance in the relationship between fund managers and investors.

Preference for Management Fees

• There is a preference for funds that charge management fees, as the CNMV (Spanish Securities Market Regulator) encourages such structures. Attempts to introduce funds with only success fees have not been approved.

Fee Structures in Different Fund Types

• The speaker notes that while they are not opposed to success fees, they prefer low management fees, especially for equity funds where beating the market is challenging.

Understanding Fee Value

• It’s important to understand what constitutes a "cheap" or "expensive" management fee based on the type of fund. For example, a 2% fee may seem reasonable to some investors who lack experience.

Expectations of Returns and Fee Implications

• The expected returns from fixed income assets are generally lower than those from equities; thus, high fees can significantly erode potential gains in fixed income investments.

Evaluating Management Fees Across Fund Types

Reasonable Fee Ranges

• For money market funds, any management fee above 0.25% is considered expensive. Active fixed-income funds can reasonably charge up to 0.75%-0.80%, while equity funds charging between 0.80%-1% are seen as relatively cheap.

High Fees and Performance Pressure

• Funds with management fees exceeding 1.5% start becoming costly; those over 2% require exceptional performance from managers just to break even after costs.

Comparison of Fund Classes

• The discussion highlights how different classes of funds exist—retail versus institutional—and emphasizes choosing cheaper options whenever possible.

The Concept of Clean Share Classes

Definition and Purpose

• Clean share classes are designed for investors with significant capital or those already paying for financial advisory services, allowing them access to lower-cost investment options.

Historical Context

• Until recently, clean share classes were less accessible; now they provide opportunities for smaller investors without incurring higher costs associated with traditional fund classes.

Incentives Based on Investment Size

• Fund managers often incentivize larger investments by offering lower fees; this structure aims to reward substantial contributions while maintaining operational efficiency across various investor types.

This structured summary captures key insights regarding fund management fees and their implications on investor choices and expectations within the context provided by the transcript timestamps.

Understanding Investment Classes and Commissions

Overview of Commission Structures

• The speaker discusses their commission structure, aiming to retain 1% from investments while paying out 0.50% to the fund seller or industry contacts.

• Institutional classes are introduced, which cater to large investors like pension plans and family offices, offering lower fees due to significant investment amounts.

Accessibility of Investment Classes

• Historically, retail investors had limited access to institutional classes; however, recent changes allow for collective investments that aggregate smaller contributions into larger sums.

• The analogy of purchasing cooperatives is used to explain how pooling resources can lead to better pricing and access in investment opportunities.

Business Models in Fund Management

• Different business models exist for accessing clean classes: some charge a percentage fee while others may have a flat annual fee for membership.

• Retail class investments remain traditional despite the emergence of new models; many still incur additional costs not present in institutional classes.

Perception of Management Fees

• A higher management fee does not necessarily equate to better fund quality; it can be likened to luxury brands where price does not always reflect value.

• Investors often stick with familiar funds due to brand trust, even if they might be overpaying compared to other options available.

The Importance of Comparative Performance

• Clients may overlook fees when returns are positive but fail to compare their performance against similar funds with lower fees.

• Mediocre results from high-fee funds can go unnoticed by clients who do not actively seek comparisons with competing products.

Challenges Faced by Traditional Funds

• Large banks often package products with high commissions but deliver average results; clients may remain unaware unless they compare their performance directly with peers.

• Many bank-managed funds are overseen by small teams managing diverse portfolios, leading them away from specialized strategies that could yield better outcomes.

Competitive Landscape Shift: ETFs

• The introduction of ETFs has changed the investment landscape significantly, providing more accessible options at lower costs compared to traditional mutual funds.

• A sports analogy illustrates the competitive disadvantage faced by generalist fund managers versus specialized teams dedicated solely to specific investment strategies.

Recommended Reading on Investing

• The speaker recommends "Cero a Inversor" series by Luis as valuable resources for understanding investing concepts simply and effectively.

Understanding ETFs and Their Costs

Introduction to ETFs

• The speaker introduces the concept of ETFs (Exchange-Traded Funds), highlighting their cost-effectiveness due to the absence of a traditional manager.

• It is noted that while ETFs were historically index-based, there are now active ETFs that resemble mutual funds, leading to increased management fees.

Cost Structure of ETFs

• Typical management fees for most ETFs range from 0.10% to 0.40%, with variations depending on the type of investment (e.g., bonds or cryptocurrencies).

• Competition in markets like the UK leads to lower fees compared to Spain, where fewer options result in higher costs.

Additional Costs Associated with ETFs

• Besides management fees, investors should consider other costs such as spreads and broker commissions when investing in ETFs.

• The spread represents the difference between buying and selling prices, which can significantly impact investment returns.

Understanding Spreads

• The speaker explains how spreads work similarly for both stocks and ETFs, emphasizing that low trading volume can lead to wider spreads.

• A practical example illustrates how a €1 spread on a €10 ETF purchase equates to a 10% cost, stressing the importance of understanding percentage impacts rather than absolute values.

Broker Transparency and Investment Decisions

• Brokers typically display best buy/sell prices but may not highlight high spreads effectively; this lack of transparency can mislead investors about true costs.

• Some brokers provide alerts for high spreads, suggesting better practices could enhance investor awareness regarding potential losses due to spread costs.

Comparison with Mutual Funds

• Unlike ETFs that fluctuate throughout trading hours based on supply and demand, mutual funds have a fixed daily net asset value (NAV), eliminating concerns over price discrepancies during transactions.

Understanding ETFs and Investment Costs

The Nature of ETFs vs. Traditional Funds

• The choice between CTF funds and ETFs depends on the investor's need for agility; ETFs offer quicker transactions compared to traditional funds, which can take several days to process.

• Unlike traditional funds, the price at which an ETF is traded can differ from its actual value, similar to real estate pricing dynamics where market offers dictate final sale prices.

• Investors often start with a negative balance when trading ETFs or stocks due to spreads; this reflects the difference between buying and selling prices immediately after opening a position.

Hidden Costs in Fund Investments

• There are additional costs associated with fund investments that investors may overlook, such as custody fees charged by entities that sell funds without receiving payment from fund managers.

• Many popular banking funds in Spain impose subscription or redemption fees if money is withdrawn before a specified target date, potentially reaching up to 5% of the investment.

Understanding Management Fees and Total Costs

• It's crucial for investors to differentiate between management fees and total expenses; regulatory bodies have standardized how these costs are presented but not all components are included in initial figures.

• Success fees are typically excluded from reported costs; thus, investors should consult annual reports for a complete breakdown of what they have paid over time.

Evaluating Cost Efficiency in Fund Selection

• While monitoring costs is important, it’s essential not to dismiss potentially beneficial funds solely based on higher management fees; sometimes higher-cost options may yield better returns than cheaper alternatives.

Investment Strategies and Key Considerations

Importance of Cost in Investment Decisions

• The speaker discusses the tendency to choose the cheapest investment option, emphasizing that cost is just one of many variables to consider.

• Different types of investors prioritize various factors; for some, commissions are central to their decision-making process.

• The speaker uses commission as a last resort metric when differentiating between funds, rather than a primary criterion.

Evaluating Fund Managers

• A poor fund is often dismissed not solely due to high fees but because of an unconvincing management team or inconsistent performance.

• Inconsistent results from fund managers can lead to skepticism, especially if they manage multiple strategies without focus.

Final Selection Process

• When narrowing down options among similar funds, the speaker prefers selecting the least expensive option if all other conditions are equal.

Advice for New Investors

• The speaker emphasizes honesty with oneself about investment goals and risk tolerance when starting out in investing.

• Many new investors underestimate their ability to handle market downturns and may misjudge their emotional resilience during losses.

Understanding Risk and Uncertainty

• It’s crucial for investors to acknowledge that uncertainty is inherent in investing; being prepared for potential losses is essential.

• The discussion concludes with a reminder that not everyone may be suited for investing, suggesting some might be better off with alternative savings products.