Your coffee break investment plan - Day 5: The importance of keeping charges low

Investment charges may not seem very threatening but even small differences in fees can do tremendous long-term damage to the value of your investments. That means it’s really important not to overpay for funds or investment platforms, warns Justin Modray, founder of Candid Financial Advice.

“Let’s assume you invest £10,000 over 10 years with an average annual return of 6% before charges,” he says. “With no charges your £10,000 will have increased to £17,908. But an annual charge of 1% would reduce the end sum to £16,289 and 2% would bring it down to £14,802.”

However, there’s no point buying the cheapest funds if they’re not going to make you any money so the trick is to strike a sensible balance between keeping charges as low as possible and getting access to good fund managers who will grow your investments.

There are three main costs:

The good news is that all three can be reduced.

How to reduce charges

Patrick Connolly, a chartered financial planner with Chase de Vere, says: “It is only acceptable to pay higher fund manager charges if you are being compensated through better performance.”

The most obvious way to reduce your costs is by opting for passive – rather than active – fund management. These products are often referred to as trackers because they attempt to replicate a stock market index, such as the FTSE 100 index of the biggest companies listed on the London Stock Exchange, rather than beating it.

The main difference between passive and active is that with passive you don’t have a fund manager making investment decisions. This naturally reduces the costs to around 0.1 per cent, rather than 0.85 per cent. It may sound insignificant but it will add up over time.

You could also consider exchange traded funds (ETFs), which have grown in popularity over the past decade. These products provide access to a wide range of different investments – including exposure to various countries and asset classes – at relatively low cost.

Their ‘passive’ approach makes them similar to tracker funds but the difference is that they are traded on the London Stock Exchange like shares in UK companies. You can buy and sell them at any point in the day while the stock exchange is open for business.

Opting for a passive fund doesn’t automatically mean you will miss out on performance. Although you will never beat the market, when you factor in that many active managers underperform the index that they are trying to beat, a tracker may be the wisest move.

Investors seeking to reduce charges need to be particularly wary of multi manager funds, warns Mr Connolly. “These are investment funds that invest in other investment funds and so have an extra layer of charges,” he explains. “The performance has to be good enough to make up for these fees.”

Then there are fund platforms.

“Many people now hold their investments on a platform and this makes sense if you want to use the extra flexibility that a platform can provide, although charges for these services can vary considerably, from around 0.25% per annum to 0.45% per annum,” he says.

To compare costs visit the website

So how about financial advice?

“If your investment needs are quite basic then you probably don’t need to take financial advice but as your investment amounts grow it becomes more important to get your investment decisions right, so not having an adviser might prove to be a false economy,” says Mr Connolly.

If you missed them, make sure you read the first articles in this series.

Day 1: What is investing?

Day 2: What is the stock market?

Day 3: Setting investment goals

Day 4: The two enemies of investors: Inflation and tax

Also watch Moneywise editor Moira O’Neill interview Andy Parsons from The Share Centre about why you should start investing.

Coming tomorrow:

Day 6: Having a range of eggs in your basket