Focus on your true net returns

Yesterday, Vanguard Investments Australia released some research highlighting the significant impact that tax has on investor’s returns. Read the report here.

The report focuses on the 15 largest wholesale Australian Equity (Share) Funds. Presumably this sample was selected to represent the impact on a majority of investors in such funds.

Tax is a big cost

The analysis highlights the importance of focussing on more than just total return when considering managed fund investments. Of the funds surveyed, on average three-quarters of the total return was in income with the remainder in capital growth. With capital gains in Australia potentially taxed at half that of income, the fact that most of the return was income is a significant cost to the investor.

Vanguard uses the research to highlight the benefit of investing in passive index funds such as their own funds. But I’d like to expand that to encourage you to consider all the costs of investing including tax, transaction costs, advice fees and also your time. All of these impact on your net return and it is your net return that determines how rapidly your wealth increases.

The counter-argument to the one promoted by Vanguard is that people want to get the best returns. Subsequently they are willing to invest time and money in researching actively managed funds that hopefully will deliver higher gross returns to make up for the higher fees and potentially higher tax. But does that actually happen?

Your time is a big cost too

To assess the answer to that question I will focus on the same sector as the Vanguard research: Wholesale Australian Equity funds.

To benchmark the above funds I will use a market index: the S&P/ASX 200 Accumulation index, which returned 28.7 percent for the year to 30th June 2007. (Source: van Eyk Research).

Of the 186 funds in this sector, over the past year nearly three-quarters of the managed funds achieved a gross return after internal management fees at or less than the comparable market index. So they haven’t really added value for their management fee. And if you spent time trying to chase the best returns from an active fund it is likely you haven’t received a reasonable reward for the time you invested.

The picture doesn’t get any better if you expand the view to 3 year or 5 year periods.

Count the total cost

Before spending oodles of hours researching and trying to find “the best” investment consider if it is likely you will get a return for all of the time you invested.

And remember to consider the tax implications of active management. Frequently buying and selling to chase “the best” return may cost you much more in tax thereby counteracting any benefit.

Rather than pouring over the financial pages of the newspaper perhaps you will receive a much better life return by leaving your investments alone and instead sitting down and reading the latest Harry Potter book…