Fees reduce investment returns so significantly that the SEC issued a bulletin-warning alert about the long-term effect of fees on investment portfolios. In the SEC bulletin, they compared the effect of fees on a $100,000 investment for a twenty-year period. Even when investments are for shorter periods, one can assume the money made will be re-invested, so a twenty-year time horizon is a good way to look at the long-term effect of fees on investment portfolio returns.
In the SEC example, they used a very modest 4% annual return, assuming that in some years, the investor might do better than that, but in other years, they might do worse, noting that the effect of fees is lessened if the returns were higher. On the other hand, when returns are abysmal or go into the negative, the impact of fees is more dramatic. In general, what happens from an annual fee is an erosion of the initial investment capital.
For $100,000 invested at the average annual return of 4%, without fees the investment returns $120,000 to bring the portfolio value to $220,000 at the end of twenty years. The SEC compared annual fees of 0.25% with both 0.50% fees and with 1.0% annual fees. Over a twenty-year period the portfolio with a 0.50% fee loses $10,000. The portfolio with a 1.0% fee loses $28,000.
Additionally, there is the opportunity cost of the lost investment money, which could have been invested therefore increasing the overall portfolio returns through the effect of compounding. This opportunity cost for a 1.0% annual fee is the amount of extra money that could have been earning on the missing $28,000, which equals another $12,000 for a total of $40,000 in lost investment returns. This amount is one-third of the total return of $120,000 on original investment if there had been no fees.
There are a variety of fee structures in crowdfunding deals, which range from investment offerings that have no fees to those with annual fees as well as partial participation in upside returns above the preferred returns offered and participation in profits on exit.
For comparison purposes, look at the difference in returns from recent investment offerings of Real Crowd, Realty Share, and iFunding. Real Crowd has no ongoing fees charged to the project, because the sponsor pays them to list the investment offering. Realty Share typically has a 1% annual fee. iFunding standard is a 2% annual fee and participates in any returns above the preferred rate of 10% annual return by taking 20% of the extra return.
For a hypothetical investment of $100,000 with a preferred annual return of 10% and a 50% extra profit on exit after year five, here is how the calculations work out when comparing these three investment programs:
|Initial Investment||$100,000.00||Yr1||Yr2||Yr3||Yr4||Yr5||EXIT||TOTALS||Gross Profit||IRR||Annualized|
|70% to investor|
|Return||10% per year||$10,000.00||$10,000.00||$10,000.00||$10,000.00||$10,000.00||$35,000.00||$85,000.00|
|Real Crowd||no fees||$0.00||$0.00||$0.00||$0.00||$0.00||$0.00||$0.00||$85,000.00||85.0%||17%|
|Realty Share||1% annual fee||$1,000.00||$1,000.00||$1,000.00||$1,000.00||$1,000.00||$0.00||$5,000.00||$80,000.00||80.0%||16%|
|iFunding||2% annual fee||$2,000.00||$2,000.00||$2,000.00||$2,000.00||$2,000.00||$7,000.00||$17,000.00||$68,000.00||68.0%||14%|
Real Crowd makes a total return of $85,000 on the $100,000 investment for a total IRR of 85% or 17% per year. Realty Share makes a total return of $80,000 on the $100,000 investment for a total IRR of 80% or 16% per year. iFunding makes a total return of $68,000 on the $100,000 investment for a total IRR of 68% or only 14% per year.
From these examples, it is clear that fees and exit participations significantly influence overall investment returns, so investors would be wise to take a very careful look at the fees and participations in any deal.