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 fund manager’s fee for managing the investments.
- the investment platform’s charges for buying, holding and selling your investments.
- any cost of financial advice that you take.
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 comparefundplatforms.com.
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.
Also watch Moneywise editor Moira O’Neill interview Andy Parsons from The Share Centre about why you should start investing.
Day 6: Having a range of eggs in your basket
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%.
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
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.
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 increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).