Watch out for fees and charges

Main charges

There are two main charges on investment funds such as unit trusts and open-ended investment companies – the initial charge, which you pay when you first invest, and the annual management charge, which is taken over the year.

Initial charges are around 5%, and normally include a 3% commission which is paid to the introducing adviser. Annual charges vary between 1% and 1.75% depending on the type of fund.

"The costs associated with managing your money can be very expensive," says Ian MacArthur, director of independent financial adviser Sterling Financial Services.

"During a five-year period, assuming moderate investment growth, charges could easily amount to more than 15% of the amount invested."

Take the ABC fund, for example. This fund has an initial charge of 5% and an annual charge of 1.5%. If you invest £100, £5 will be swallowed up in the initial charge, leaving you with £95 invested.

If this grows by 6% a year, you would have £100.70 at the end of the first year, before charges. Once charges are deducted, however, this would drop to £99.19 - less than you started with. 

Some funds have much lower charges. Tracker funds, where the investment decisions are made by a computer programme, can be cheap. For instance, the HSBC FTSE 100 Tracker has no initial charge and an annual management charge of 0.25%.

The real cost

However, the quoted figures are only part of the story, as MacArthur explains: "Investment funds also have underlying costs and charges such as auditors, custodian and registrar fees that are deducted from the fund.

"To see the full extent of all the annual charges you need to look at the total expense ratio or TER."

To illustrate this, MacArthur points to the Invesco Perpetual High Income fund, which has an annual management charge of 1.50%, but a higher TER of 1.69% because it factors in these additional charges. 

The difference between quoted annual charges and the TER is most marked on funds of funds, where an investment fund invests in other investment funds  – effectively creating two tiers of charges.

"A TER of 2.50% wouldn't be unusual for this type of fund," MacArthur adds.

Sometimes it can be worth paying extra, though. For instance, MacArthur says the Jupiter Merlin Income fund, which is a fund of funds, has a TER of 2.33% but produced performance of nearly 40% over the last five years.

"This is significantly more than some of its cheaper counterparts," he says. "The average fund in the sector returned just 16.48% over the same period." Popular fund managers also tend to charge more.

Discount options

Whether or not a fund justifies its fees, it's never worth paying more than you need to for an investment.

Discount brokers and fund supermarkets can help you invest for less. Among some of the largest are FundsNetwork, Hargreaves Lansdown's Vantage, FundsDirect, Interactive Investor, Bestinvest and Chelsea Financial Services.

These will slash the initial charge, usually to zero, and will often reduce the annual charge too.

However, there is a downside: although you'll be provided with plenty of information to help you make your choices, you won't get any personalised advice or direction on what you should do.

The decisions you make are solely down to you. This means fund supermarkets and discount brokers tend to suit the more experienced investor.

IFA savings

But you can still make savings from an independent financial adviser or IFA – even if you just want advice.

Many of these will rebate some of the commission they receive through the initial charge, typically reducing this from 5% to 2%, so you'll still get a better deal than if you bought direct from the investment company.

Find an IFA