How to cut the cost of investing
Picking the best and most suitable investments, be they shares or funds, is a challenge in itself but ensuring you are not paying an arm and a leg in charges can be a whole other task.
For festive reasons, some of us may not remember New Year's Eve 2012, but it ushered in a huge overhaul of the UK's investment industry when the City regulator introduced new legislation, called the Retail Distribution Review (RDR).
Its primary goal was to make the cost of investing more transparent by eradicating the practice of product providers paying financial advisers commission for recommending their products, a situation which was often exploited by unscrupulous intermediaries.
Now investors have to pay upfront for advice, either via a percentage fee or an hourly rate, averaging around £150. While the intentions were good, the move has arguably made the complexity of investing more intricate for consumers.
Getting down to the true cost of investing can mean labouring through a minefield of jargon. But paying too much for the privilege of investing can seriously erode your returns.
Justin Modray, founder of comparefundplatforms.com, a specialist website that analyses the costs of investing, says: "It is vital to look at the bottom line, especially if you use an adviser, discount broker and/or fund platform. Focus on how much you will end up paying after all fund charges, fees, discounts and rebates. You may be surprised: some services that purport to be cheap are actually pretty expensive. If you are opting to get advice, do not be afraid to shop around until you find one you can trust and make sure they are independent."
The costs incurred by using a financial adviser will ultimately depend on what deal you will come to with them and how much help you need. You can check unbiased.co.uk to find an adviser in your area and bear in mind many good advisers will be happy to offer a free initial consultation.
Here's what you need to know and what you should expect to pay when it comes to investing.
Initial charges are quoted for funds and are generally around 5%. They represent the one-off upfront cost of investing but it can be avoided by not buying direct from the fund manager. Discount brokers and fund platforms typically rebate commissions to investors, reducing the initial charge to zero.
Annual Management Charge
For an actively managed fund, where a fund manager selects individual stocks on your behalf, the average Annual Management Charge (AMC) is between 1.5% and 1.75%. A discount broker or fund platform may help you shave some of this off, too. There are now two types of charging following the implementation of the RDR: funds that still include commissions and platform (fund supermarket) fees called 'retail' versions; and those that do not, known as 'clean' versions.
Clean versions typically charge around 0.75% less, therefore annual charges tend to be around 0.75% and 1%.
Total Expense Ratio (TER)
This is the bottom-line fee for any fund investor to take note of. The TER, sometimes referred to as an 'ongoing charge' includes the annual management charge as well as other 'hidden' costs such as dealing and regulatory fees, incurred by a fund, which can add 0.1% to 0.2% or more to the overall annual cost.
These are an extra layer of charging investors can be hit with after a fund delivers a sufficient level of positive returns to its investors, but they are not very common among retail funds.
Shares and funds
You can buy and sell shares via a stockbroker. These days, deals are usually made online but they can be made over the phone, even though the latter option costs more. Trading online means you can view your portfolio whenever you wish and there are even apps that allow you to trade on the go.
Costs vary between brokers, averaging around £10 for each UK trade. If you wish to buy individual stocks from further afield, such as shares in Apple, which is listed on the US Nasdaq stock exchange, the trading costs will rise to between £15 and £20. Avoid stockbrokers that charge a percentage, as opposed to a fee, particularly if you have a smaller portfolio.
Most online sharedealers sell shares on a 'nominee' basis. This means shares are held on your behalf by your provider. While this means you won't get a share certificate, it does reduce your costs. In addition, find out how much it costs to re-invest dividends - profits shared out by companies to shareholders. Some low-cost brokers charge their usual dealing fee for reinvesting while others offer a discounted rate.
Finding the best-value stockbroker largely depends on how often you trade. If you only trade a few times a year, then avoid quarterly account fees. Some brokers also have 'inactivity charges' if your trading activity is sparse.
When you invest in a fund, your money is combined with that of other investors and used to purchase a spread of different investments by a fund manager. Active fund managers pick stocks in a bid to beat a particular market, such as the FTSE 100; while other cheaper funds, known as index trackers, slavishly follow an index.
Investors need to pay attention to two specific types of charges when investing in a fund, the 'initial charge' and the annual cost or TER.
Never buy direct from the fund manager, as upfront charges can be high. But you should not expect to pay an initial charge these days.
Tracker funds can be had for as little as around 0.2% a year while actively managed funds tend to be around 0.75% to 1% a year for 'clean' versions. But to get these low charges, you have to buy via a fund platform or discount broker, the most popular options for investors.
The price of investing through these portals can depend on what funds you are invested in. Alliance Trust Savings, Sippdeal and Cavendish Online tend to be among the most competitive for direct and ISA holdings. Alliance charges £48 a year and Sippdeal £50 a year while giving access to lower-cost, clean fund versions. Cavendish Online uses retail versions but rebates all commissions, which means most actively managed funds come out at around 1% a year.
Investment trusts and ETFs
As with funds, when you invest in an investment trust, you pool your cash with other investors to purchase a wide range of stocks. Investment trusts have never paid sales commissions, so do not levy initial charges.
Like shares, they are traded on the stockmarket so a low-cost broker such as SVS Securities is the cheaper route, though costs will incur stamp duty.
Ongoing charges can vary from 0.3% to more than 1.5%, depending on the size of the trust and how the fund is investing.
According to the Association of Investment Companies, the average equity portfolio's 'ongoing charge' is 1.21%. Some investment trusts charge a performance fee, too. You can see a full list of charges at theaic.co.uk.
Exchange traded funds (ETFs) are just like tracker funds in that they mirror the movements of a particular market or index such as the FTSE All-Share - given they are not actively managed, the costs are cheaper too.
They differ from trackers in that they are listed on a stock exchange and, as such, are traded like shares, with the same cost implications - but free from stamp duty. Most ETFs charge around 0.2% to 0.6% a year depending on the index being tracked. Unlike tracker funds, ETFs do not have a monthly savings option, so if you invested regularly, on each occasion you would be paying the dealing charges, which would eat into your returns.
'Clean' pricing will benefit investors
The investment industry is currently in a state of flux. Although advisers can no longer receive commission from fund managers, execution-only operators (where no advice is given) such as discount brokers, and fund platforms may still do so until April next year, when a new tranche of regulation arrives - the so-called 'Platform Paper'.
Currently, investors usually just see a headline fee when they invest in funds via an execution-only service; they do not, however, know how the fee they pay is split between the fund provider and the broker. But the incoming rules will force execution-only services to disclose the breakdown between what they are taking and what the fund provider is receiving, known as 'clean' pricing.
This increased transparency should hopefully mean a better deal for investors as it should force broker costs to become more competitive and levy smaller costs on investors. You can compare investment costs via a calculator at trueandfair.com.
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.
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%.
Often used by stockbrokers to ease the administration of buying and selling holdings on behalf of their clients, a nominee (the broker) holds securities on behalf of investors (the “beneficial owners” of the securities). Holding securities through a nominee is cheaper, but the disadvantage is that beneficial owners of shares forego certain rights enjoyed by shareholders on the register, such as the right to vote at an annual general meeting (AGM) or extraordinary general meeting (EGM) and the right to propose AGM or EGM resolutions. Holding securities through a nominee still entitles the shareholders to dividends, rights issues etc.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
Describes the relationship between a client and a stockbroker or independent financial adviser whereby the broker or adviser acts solely on the client’s instructions and doesn’t offer any advice on which shares to invest in or financial products to buy and simply “executes” the wishes of the client, regardless if they are judged to be sound or wrong. Other types of broking service offered are advisory (whereby the client/investor makes the final decisions, but the broker offers advice) and discretionary (whereby the broker manages the portfolio entirely and makes all the decisions on behalf of the client).
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.
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.
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%.