In periods of poor stock market returns, keeping charges low becomes even more important.
Here's a frightening statistic. According to Virgin's website, investors have some £1.2 billion invested in its FTSE Tracker ISA, which was launched to great acclaim back in 1995. This is worrying, because Virgin's product palpably fails to do what it says on the tin -- track.
While the FTSE All-Share index has grown 144% (including dividends) since Virgin launched its tracker, the tracker itself has grown just 109%, a difference of some 35 percentage points. Apparently, over 200,000 people bought Virgin's tracker in the two years after its launch. And the last that I heard, over 90,000 of those people were still invested in the fund.
Charges matter
Regular readers know all too well the importance that the Fool attaches to low-cost index trackers, with especial emphasis being attached to the first two words: low-cost.
And it's Virgin's 1% annual charge that has made a significant contribution to that under-performance. Simply put, the greater the slug of dividend income held back as charges, the less will be available for re-investment and subsequent compounding.
Virgin isn't alone, of course. There are a number of high-cost trackers out there, including some charging even more. And -- believe it or not -- some even charge an upfront initial fee as well. Incredibly, some -- such as St. James Place -- do both.
The Lost Decade
Roll the clock back, and investors in such high-cost trackers were probably sanguine about the charges they were paying, because the stock market returns that they were expecting were many times higher.
Here on the Fool, for instance, it's been said many times that since the end of the First World War, on an income reinvested basis, the UK stock market has produced an average annual return of around 11%. If you're getting 11%, goes the logic, what are you really missing out on by giving one percentage point of that away?
But if that argument ever was valid, the past ten years has blown it out of the water. The prestigious Barclays Equity Gilt Study -- published every year since 1956, and looking at UK stock market data going back to 1899 -- has called the past ten years 'the lost decade'.
Why? Because stock market returns fell far short of that nice fat 11% a year. A long, long way short. According to the study, in fact, the UK stock market delivered an annual average return of 1.05%, its second-worst ten year period ever. (The other was the ten-year period ending in 1974.)
So let's see. You're earning 1.05% a year from the stock market, and you're paying your tracker manager 1% a year. Leaving you with -- gosh -- just 0.05% for yourself. And that's before taking into account inflation. As the study points out, "In both the US and UK, the real total return from equities over the past decade has been negative."
Put like that, tracker charges take on a far more significant role in investment decisions. Why give away almost all your return to the tracker manager? The less you give the manager, the more there is left for you.
Will history repeat itself?
Back in January 2001, after the collapse in markets that took place in 2000, the Sunday Times predicted that the stock market would rise during 2001. For the stock market to fall two years running is most unusual, it said, reporting the number of times this had happened. The following year, a rise was again predicted. The logic? For the stock market to fall three years running is most unusual... The following year? Yes, you guessed it.
I don't think that we'll see further year-on-year falls. But the point is, I don't know that they won't occur. And neither does anyone else. So I'm continuing to invest.
What I do know is that when the economy and the markets do eventually recover, the climb back to prosperity is likely to be slow and arduous. Simply put, I don't think we'll be seeing 11% a year for much of this decade, either.
Focus on costs
And that being the case, tracker charges remain very important. Invest in a high-cost tracker, and you're giving away a significant proportion of the total available return.
When Virgin launched its fund, its charges were seen as modest. Which is a welcome sign of how the tracker landscape has changed in the intervening 15 years. For low-cost then isn't low-cost now. Legal & General's flagship UK Index FTSE All-Share tracker, for instance, the UK's most popular tracker fund, has annual charges of just 0.52%. Fidelity's MoneyBuilder UK Index tracker comes in even cheaper, charging 0.27%.
And the long-awaited arrival of Vanguard looks set to drive charges down even further. As reported on the Fool, Vanguard's tracker has an annual cost of just 0.15%.
Virgin remains defiant: as recently as this week, Virgin spokesperson Scott Mowbray was still defending the 1% fee. But while Virgin might be publicly sanguine about the impact of Vanguard's arrival on its business, others aren't: HSBC, for instance, has already cut charges right across its tracker range, charging 0.27% for its three UK-based trackers. Others will hopefully follow.
In the meantime, take a look at what you're paying for your tracker, and ask yourself a simple question: If what I'm paying in charges was a good deal back when I took it out -- is it still a good deal today?
Malcolm's delightful wife Mandy has Legal & General's UK Index tracker in both her ISA and SIPP.
