Investment fund charges explained
There are two main types of fund charges you will need to consider: one-off and ongoing fees. In addition there will be a number of other costs to take into account. Although you will need to clarify charges with fund providers, these should give you an overview of what to expect.
- Read about why it's so important to keep charges low.
Most investment funds and platforms no longer impose initial charges. However, with some providers an entry charge of up to 5% entry charge of up to 5% may be taken from your money before your investment is placed or units are purchased. Sometimes funds will levy exit charges, but these are rare.
ONGOING CHARGES FIGURE (OCF)
OCF is the new term for the total expense ratio (TER) and gives the most accurate measure of what it costs to invest in a fund. It is made up of the annual management charge (AMC) and a variety of other operating costs.
These charges cover the cost of running the fund. They include administrative costs such as maintaining records, producing reports and calculating the daily unit price, as well as the research that goes into deciding what assets to buy and sell.
In addition to the OCF there will be the trading costs associated with buying and selling assets within the fund. These are a necessary evil for investment funds and will be paid from the fund. These charges will be higher for funds that trade regularly and less for those adopting a longer-term, buy and hold approach. The hope is that the extra returns made from successful trades will outweigh the costs involved.
Stamp duty is the biggest of these costs. It is not part of the OCF and is disclosed separately in funds’ annual reports and accounts.
Total trading costs cannot be compared in a meaningful way because the markets for different types of asset operate in different ways. However, the industry regulator, the Financial Conduct Authority, is reviewing investment fund charges and transparency. It is hoped that this will result in an overall charge figure for funds with nothing left out. This would make it much easier to compare the charges of different funds.
These reward the investment manager for superior returns or outperforming expectations. Only around 100 of approximately 2,500 UK funds charge performance fees. Adrian Lowcock, investment director of Architas, is not a fan.
“Generally we’re not keen on performance fees but we do buy funds that charge them when we want access to particular strategies, such as absolute return,” he says. “Sometimes the only way to get access to certain managers is through paying a performance fee.”
In addition to the charge you pay for investing in the fund, you also have to pay a fee to the platform or stock broker that you hold your investments with. This might be an annual percentage charge of between 0.30% and 0.45% of the investments held with the platform or it could be a flat annual fee of say £80 to £100.
For more on investment platform fees, read Our guide to the best investment platforms for beginners.
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).
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.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
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%.
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.