10 ways to invest on the cheap
When we look to invest money, it's very easy to focus on the investment performance of particular products - but cutting the cost of your investments can also help improve returns - especially when consistent strong performance is hard to come by. Here we look at 10 ways to invest on the cheap.
1. Use a tracker fund
The idea of a tracker fund is to replicate a particular index such as the FTSE 100, instead of trying to beat it. This means you don't have to pay the costs of a fund manager to actively manage the portfolio, so the overall cost of the investment is lower. Typically, you will pay an annual management charge (AMC) of 0.5% rather than 1.5%.
This idea is particularly attractive when you consider that a lot of active fund managers actually fail to outperform. However, there are some potential downsides, according to Geoff Penrice, a financial adviser with Honister Partners.
"Not all trackers are the same: the way they track can vary, so an investor must have an understanding of exactly what they are investing in," he explains.
For instance, the top-performing FTSE 100 trackers beat the average by more than 1.8% over the 12 months to 4 October, while the best FTSE All Share tracker, the Virgin UK Index Tracking Trust, was 3.3% ahead of the average for All Share trackers.
Trackers also follow the market down as well as up, so there's no way of defending yourself against losses in a declining market - whereas a good actively-managed fund will tend to outperform a falling market.
2. Shop around for a stockbroker
If you're trading shares, stockbrokers have different charging structures. Some demand a fixed fee, while others base fees on a percentage of the sum invested. So it is important to have an idea of what amounts you want to invest and how often you plan to change your holding.
You must also decide on the level of service you need. The cheapest option is 'execution only', where the stockbroker just acts on the client's instructions. It's possible to buy and sell shares online for under £6 per trade (for instance through jpjshare.com or x-o.co.uk), but some traditional stockbrokers still charge over £50. So look for the cheapest deals.
3. Use a fund supermarket
A fund supermarket such as Fidelity FundsNetwork or Interactive Investor allows your funds to be held on a single trading platform, reducing paperwork and giving you a perspective on the asset allocation and performance of your overall portfolio.
Using a fund supermarket allows you to select from a wide range of investment funds. The initial charge is discounted and in many cases waived altogether, and subsequent fund switches are quick and cheap. "The charges levied for moving funds tend to be lower, at around 0.25% of the funds moved," says Penrice.
4. Compare costs between funds
Fees levied by investment houses differ, even when their funds are operating in the same sectors, warns Patrick Connolly, spokesperson for AWD Chase de Vere. "It's important to understand exactly how much you are paying and what you are getting in return."
It can also be hard to understand the charging structures. "There is the AMC of, say, 1-1.5% for an active fund, as well as other costs," he says. "When these are added to the AMC, it is expressed as the total expense ratio (TER). But there will be dealing charges on top, so the more frequently a fund portfolio is traded, the higher the costs will be."
However, well run, high-charging funds may produce higher returns than poorly run, lower-cost funds.
5. Use your ISA allowance
Using your ISA allowance means that you pay less or no tax, and this will improve the overall returns on your investments. A couple able to invest their combined allowance (currently £10,680 each) each year could amass almost £300,000 in 10 years, assuming 4% annual growth and no rise in the annual allowance.
Dividend-paying investments are taxed 10% at source and this is not reclaimable within an ISA, but interest-paying investments such as corporate bonds and cash are truly tax-free, points out Justin Modray, founder of financial website Candid Money.
"A higher-rate taxpayer would save more than £100 a year when investing their £10,680 annual allowance in dividend-paying equity funds yielding 4%, or more than £250 if they held corporate bond funds."
6. Consider ETFs
Exchange traded funds (ETFs) give you access to a wide range of investments at low cost. Their 'passive' approach makes them similar to tracker funds, but the difference is that they are traded on an exchange, like a share.
There are plenty of ETFs to choose from and a variety of ways that they can be constructed. Modray says: "As they're traded on the stock exchange you'll have to pay stockbroker dealing fees, but there's no stamp duty. These products can be an attractive alternative to more expensive actively-managed funds."
7. Embrace pound cost averaging
Regular monthly investment - paying a set amount each month to buy units of a fund at whatever price they are available - can make a lot of sense. "If you regularly invest £200 into a fund and have been buying units at £8 each, when the price falls to £6 you will get more units for your money," explains Darius McDermott, managing director of Chelsea Financial Services.
When markets are volatile, you're likely to end up with more units bought at a lower average price than a lump sum investor, which is known as pound cost averaging. Regular saving also takes the guesswork out of timing your investment.
Conversely, there may be occasions when it pays to invest a lump sum, as you can sometimes benefit from lower charges, but this must be balanced against the risk of investing before a market fall.
8. Consider multi-asset funds
Buying and selling funds incurs costs, and so you will save money if you select funds you can hold for the long term, argues Connolly.
"The best way to do this is to select a fund that invests in a wide range of different investments including shares, fixed interest and property, with the relative balances adjusted by the manager as circumestances change," he says. "A good choice is Cazenove Multi Manager Diversity."
These funds have an added bonus. As no single asset class can be guaranteed to top the performance charts every year, exposure to a broad mix of investments means you are less vulnerable to a fall: when one is going down, others are hopefully thriving.
9. Be wary of multi-manager funds
The idea behind multi-manager funds is pretty compelling. You buy into an investment fund whose manager buys a range of other funds, rather than individual shares. The benefits are that you have a ready-made fund portfolio and also increase your chances of success by tapping into the expertise of specialists in various areas.
The downside, however, is that you will be paying an extra level of charges because you have two sets of manager fees.
"These funds do have a role to play but if they have total annual costs of more than 2% then they have to perform very well to justify the high charges," Connolly says.
10. Keep an eye on other fees
There's a good chance your existing investment funds are paying around 0.5% annual trail commission to either a financial adviser or a fund supermarket, according to Modray.
"If you don't need advice then change the 'agency' on the funds to a good discount broker who will rebate this commission to you," he says. "Cavendish Online is currently the cheapest, rebating all trail commission in exchange for a one-off £25 fee."
Separately, more investment funds are being launched with performance fees built in on returns above a certain level, as well as set annual charges.
Performance fees are heavily used in Absolute Return funds, where some managers set themselves low hurdle rates so they can earn performance fees for achieving modest returns.
All investment returns are measured against a benchmark to represent “the market” and an investment that performs better than the benchmark is said to have outperformed the market. An active managed fund will seek to outperform a relevant index through superior selection of investments (unlike a tracker fund which can never outperform the market). Outperform is also an investment analyst’s recommendation, meaning that a specific share is expected to perform better than its peers in the market.
Investment funds that invest in other investment funds from a wide range of asset managers and are often referred to as funds of funds. Some multi-manager funds only invest in the funds of the investment house providing the fund of funds and these are known as “fettered”. An “unfettered” multi-manager fund is free to invest in what the fund manager believes are the top performing funds from across different markets and industries. Investing in multi-manager funds means your risks are spread across geographical regions and industry sectors but it also adds another layer of charges and some multi-managers also levy an out-performance fee.
Usually charged as a percentage of returns for performance above a specified benchmark, such as an index. The fee can range from 10% to 20% of total investment returns on a low starting benchmark such as Libor and investors could find themselves paying extra fees for merely average performance. Note that these funds do not compensate investors when the manager underperforms the benchmark.
Total expense ratio
Most investment funds levy an initial charge for buying the units/shares and an annual management fee but other expenses also occur in running the fund (trading fees, legal fees, auditor fees, stamp duty and other operational expenses) which are passed on to the investor and so the TER gives a more accurate measure of the total costs of investing. The TER is especially relevant for funds of funds that have several layers of charges. Unfortunately, investment fund companies are not obliged to reveal TERs and many only publish the initial charges and annual management charge (AMC).
Also known as index funds, tracker funds replicate the performance of a stockmarket index (such as the FTSE All Share Index) so they go up when the index goes up and down when it goes down. They can never return more than the index they track, but nor will they lose more than the index. Also, with no fund manager or expansive research and analysis to pay, tracker funds benefit from having lower charges than actively managed funds, with no initial charge and an annual charge of 0.5%.
There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.
A hugely unpopular tax paid on property and share purchases. Stamp duty on property is levied at 1% for purchases over £125,000 (£250,000 for first-time buyers) which then moves up at a tiered rate. For property between £125k and £250k you pay 1%, then 3% from £250k up to £500k and then 4% from £500k to £1m and then 5% for properties over £1m. But unlike income tax, which is “tiered” and different rates kick in at different levels, stamp duty is a “slab” tax where you pay the rate on the whole purchase price of the property. On shares, stamp duty is charged at a flat rate of 0.5% on all share purchases. Figures correct as of May 2011.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
Corporate bonds are one of the main ways companies can raise money (the other is by issuing shares) by borrowing from the markets at a fixed rate of interest (the reason why they are also known as “fixed-interest securities”), which is called the “coupon”, paid twice yearly. But the nominal value of the bond – usually £100 – can fluctuate depending on the fortunes of the company and also the economy. However it will repay the original amount on maturity.
Annual management charge
If you put money in an investment or pension fund, you’ll not only pay a fee when you initially invest (see Allocation Rate) but also a fee every year based on a percentage of the money the fund manages on your behalf. Known as the AMC, the actual percentage varies according to the particular fund, but the industry average for active managed funds is 1.5%.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
Absolute return funds
Absolute return funds aim to deliver a positive (or ‘absolute’) return every year regardless of what happens in the stockmarket. Unlike traditional funds, they can take bets on shares falling, as well as rising. This is not to say they can’t fall in value; they do. However, over the years, they should have less volatile performance than traditional funds.