How to cut the costs of investing
Fees vary enormously and can have a dramatic impact on your returns. After all, there’s little point in buying a fund that delivers a bumper return if you end up paying most of it back in charges, says Jason Witcombe, spokesperson for Evolve Financial Planning.
“If one fund charges 0.5% a year and another charges 1.5%, the more expensive fund will have to produce an extra 1% each year just to keep pace,” he explains. “That’s a big ask in the current environment and most of the higher-cost funds won’t be able to achieve this.”
The most expensive funds are usually multi manager or fund of funds. These invest in other investment funds and so have an extra layer of charges. This means that the total charge you pay could be more than 2% per annum.
These differences might not sound much but the impact can be vast when measured over time, due to what is known as the cumulative 'drag' effect.
For example, a £15,240 fund investment - the current annual limit for individual savings accounts (Isas), growing by 7% each year - will reach £29,980 after 10 years before costs are added into the equation. However, annual charges of 1.65% would reduce this to £25,660, whereas fees of 2.5% would shrink it to £23,670.
Meanwhile, some low-cost index-tracking funds have annual charges of 0.3% or under, which would reduce the same investment over 10 years to a healthier £29,150.
- Read more about the importance of keeping charges low
Fees and charges
The problem with fees and charges is that they still aren’t particularly transparent. What charges apply and how much they are going to set you back can vary enormously and the whole process isn't always clear, according to Justin Modray of Candid Financial Advice.
“There is the annual management charge (AMC) and then other costs, which, when added to the AMC, will be expressed as the ongoing charge figure (OCF),” he says. “However, this isn't the full picture as there will be dealing charges on top of the OCF.”
- For more about this read Investment fund charges explained
How to cut your costs
The good news is there are plenty of ways to reduce your expenses, in terms of the products available and how you go about buying and selling them.
The most obvious way to reduce your costs is by opting for passive rather than active funds. These products are often referred to as trackers because they attempt to track an index, such as the FTSE 100, rather than beat it. As you are not paying a fund manager to make decisions, the annual costs will be lower at around 0.1%, rather than 1%.
Opting for a passive strategy doesn't automatically mean you will miss out on performance. Given that so many active managers underperform, it could be a wise move, says Mr Modray. It all comes down to individual funds.
“It's unfair to assume lower-charging funds will outperform more expensive funds because a well run higher-charging fund may give much better returns than a poorly run cheaper fund,” he says. “When a fund performs well, higher charges may seem less important, but given that no-one can guarantee performance it’s sensible to always seek out funds that offer a fair deal.”
He also argues that it’s impossible to say whether active or passive strategies are better. “Hedging your bets by combining both in your overall portfolio makes sense,” he adds.
You may also want to consider Exchange Traded Funds (ETFs), which have grown in popularity over the past decade. These 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 listed on a stock exchange, similar to a share. This gives investors relatively straightforward access to a wide variety of investments on a real-time basis.
Although ETF transactions are subject to some of the same charges as share transactions, they generally have lower management fees. They can also be traded at any time, offering investors much greater control in terms of timing. In addition, since April 2014 there has been no stamp duty payable on UK domiciled ETFs.
- It may also be worth looking at investment trusts
Investment trusts are quoted companies in which you buy shares, the price of which will be determined by supply and demand, like any other share, rather than the value of the underlying assets, meaning their value can fluctuate more than unit trusts, although fees are usually lower.
Trusts can also retain up to 15% of the income they receive each year and put it into their reserves. This process, known as 'smoothing', helps them pay dividends in more difficult years and is worth bearing in mind.
There are also other ways to cut costs. Using a fund platform could be a good idea. This enables you to hold your funds on a single trading platform, which can make it easier and cheaper to keep track of investments and to make changes.
However, you need to be cautious, points out Patrick Connolly at Chase de Vere.
“While an increasing number of investment funds are being bought on platforms, it is incredibly difficult for investors to have a clear understanding of how much they are actually paying in total platform and investment charges,” he says. “You also need to be aware that charges can differ significantly between different platforms and some also charge exit fees if you want to move your money elsewhere.”
He gives an example: “If you buy a tracker fund with an annual charge of 0.1% and a platform charge of 0.25% then your total charge is 0.35% per annum. However, if your platform charges 0.45% then your total charges goes up to 0.55% per annum, a significant increase.”
Finally, don’t forget to shield as much money as possible away from the taxman - the first port of call should be utilising the tax-efficient qualities of your annual Isa and pension allowances.
Jason Witcombe, an adviser at Evolve Financial Planning, says: “I would look at Vanguard’s range of funds as a starting point as they offer extremely low cost access to many investment markets."
Patrick Connolly, spokesperson for AWD Chase de Vere, says: “It is notoriously difficult for active fund managers investing in large-cap UK shares to outperform the index. This tracker fund gives exposure to FTSE 100 companies with an annual charge of just 0.1%."
Justin Modray of Candid Financial Advice says: “This is a rare beast, a top performing fund with a stellar management team that charges well below average. The fund’s OCF is just 0.54%, around a third less than many rivals, and it could sit well alongside an index-tracking fund for mainstream UK stock market exposure.”
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.
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.
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%.
All investment returns are measured against a benchmark to represent “the market” and an investment that performs better than the benchmark is said to have outperformed the market. An active managed fund will seek to outperform a relevant index through superior selection of investments (unlike a tracker fund which can never outperform the market). Outperform is also an investment analyst’s recommendation, meaning that a specific share is expected to perform better than its peers in the market.
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.
An Exchange traded fund is a security that tracks an index or commodity but is traded in the same way as a share on an exchange. ETFs allow investors the convenience of purchasing a broad basket of securities in a single transaction, essentially offering the convenience of a stock with the diversification offered by a pooled fund, such as a unit trust. Investors buying an ETF are basically investing in the performance of an underlying bundle of securities, usually those representing a particular index or sector. They have no front or back-end fees but, because they trade as shares, each ETF purchase will be charged a brokerage commission.
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.
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%.