One of the best ways to make sure you get your fair share of the market’s returns is to keep an eye on your overall expenses. Many actively managed investment funds have historically charged up to 2% a year in management fees. This places a huge drag on performance.

In my view, you should aim to have total fees well under 1% p.a in order to ensure the benefits of compounding go to you and aren’t whittled away by fund managers.

Here are three ways to achieve this:

1) Invest in a diversified portfolio of index funds

Index funds have emerged as a popular way to achieve cheap exposure to passive investment strategies.

With a minimum of $5,000 you can invest directly with Vanguard in a fully diversified portfolio such as the Vanguard LifeStrategy Growth Fund.

The fund invests around 70% in growth assets and 30% in income assets:

screenshot-static.vgcontent.info 2016-06-07 15-46-34

Source: Vanguard fact sheet, as at 30 April 2016.

Management fees for the first $50,000 invested are 0.90% a year, but drop to 0.60% p.a for the next $50,000 and 0.35% for anything over $100,000 invested.

The fund has annual returns of 8.5% over the last 5 years.

The advantage of funds like this is an investor can be well diversified with a small initial investment, and can grow the portfolio over time with additional contributions as little as $100.

2) Construct a portfolio of listed ETFs

Investors willing to be a little bit more hands on could replicate a similar portfolio to the one above using a low-cost broker and Vanguard’s exchange-traded funds.

Although not all of the same index funds are currently available as ETFs, a portfolio targeting similar returns would look something like this:

Exchange Traded Fund Allocation MER%
Growth Assets
Vanguard Australian Shares Index (ASX: VAS) 30% 0.15%
Vanguard MSCI Index International Series (ASX: VGS) 25% 0.18%
Vanguard Australian Property Securities Index ETF (ASX: VAP) 5% 0.25%
Vanguard MSCI Australian Small Companies Index (ASX: VSO) 5% 0.30%
Vanguard FTSE Emerging Markets Shares (ASX: VGE) 5% 0.48%
Total Growth 70%
Income Assets
Vanguard Australian Fixed Interest Index  (ASX: VAF) 12% 0.20%
Vanguard International Fixed Interest Index (Hedged) ETF (ASX: VIF) 12% 0.20%
Vanguard International Credit Securities Index (Hedged) ETF (ASX: VCF) 6% 0.30%
Total Income 30%
Total 100% 0.21%

Notice that the total management fee for this portfolio is only 0.21%. This represents a considerable saving on the above portfolio. The only extra work required would be occasional rebalancing to bring the portfolio back in line with its target allocations, and a little bit more paperwork to deal with at tax time.

It is even possible to reduce the overall fees further, depending on the chosen combination of ETFs.

Is it worth the effort?

Play around with ASIC’s managed funds fee calculator and you will see the huge impact of fees on returns.

As an example, an investor starting with $100,000 who adds $10,000 a year and earns returns of 10% will be $663,141 better off after 30 years if they pay management fees of 0.5% instead of 1.5%.

3) Include some direct share holdings

Investing in shares directly can be a great way to boost your returns and also to reduce the overall cost of running your portfolio.

Combining a 60% allocation to low-cost index funds with the remaining 40% spread across 15-20 core long term holdings purchased through a low-cost broker would enable you to reduce your overall investment expenses to a tiny fraction of 1%.

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Motley Fool contributor Matthew Bugden has shares in the Vanguard Australian Property Securities Index ETF (ASX: VAP). The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.