10 ways to invest on the cheap

6 December 2011

When we look to invest money, it's very easy to focus on the investment performance of particular products - but cutting the cost of your investments can also help improve returns - especially when consistent strong performance is hard to come by. Here we look at 10 ways to invest on the cheap.

1. Use a tracker fund

The idea of a tracker fund is to replicate a particular index such as the FTSE 100, instead of trying to beat it. This means you don't have to pay the costs of a fund manager to actively manage the portfolio, so the overall cost of the investment is lower. Typically, you will pay an annual management charge (AMC) of 0.5% rather than 1.5%.

This idea is particularly attractive when you consider that a lot of active fund managers actually fail to outperform. However, there are some potential downsides, according to Geoff Penrice, a financial adviser with Honister Partners.

"Not all trackers are the same: the way they track can vary, so an investor must have an understanding of exactly what they are investing in," he explains.

For instance, the top-performing FTSE 100 trackers beat the average by more than 1.8% over the 12 months to 4 October, while the best FTSE All Share tracker, the Virgin UK Index Tracking Trust, was 3.3% ahead of the average for All Share trackers.

Trackers also follow the market down as well as up, so there's no way of defending yourself against losses in a declining market - whereas a good actively-managed fund will tend to outperform a falling market.

2. Shop around for a stockbroker

If you're trading shares, stockbrokers have different charging structures. Some demand a fixed fee, while others base fees on a percentage of the sum invested. So it is important to have an idea of what amounts you want to invest and how often you plan to change your holding.

You must also decide on the level of service you need. The cheapest option is 'execution only', where the stockbroker just acts on the client's instructions. It's possible to buy and sell shares online for under £6 per trade (for instance through jpjshare.com or x-o.co.uk), but some traditional stockbrokers still charge over £50. So look for the cheapest deals. 

3. Use a fund supermarket

A fund supermarket such as Fidelity FundsNetwork or Interactive Investor allows your funds to be held on a single trading platform, reducing paperwork and giving you a perspective on the asset allocation and performance of your overall portfolio.

Using a fund supermarket allows you to select from a wide range of investment funds. The initial charge is discounted and in many cases waived altogether, and subsequent fund switches are quick and cheap. "The charges levied for moving funds tend to be lower, at around 0.25% of the funds moved," says Penrice.

4. Compare costs between funds

Fees levied by investment houses differ, even when their funds are operating in the same sectors, warns Patrick Connolly, spokesperson for AWD Chase de Vere. "It's important to understand exactly how much you are paying and what you are getting in return."

It can also be hard to understand the charging structures. "There is the AMC of, say, 1-1.5% for an active fund, as well as other costs," he says. "When these are added to the AMC, it is expressed as the total expense ratio (TER). But there will be dealing charges on top, so the more frequently a fund portfolio is traded, the higher the costs will be."

However, well run, high-charging funds may produce higher returns than poorly run, lower-cost funds.

5. Use your ISA allowance

Using your ISA allowance means that you pay less or no tax, and this will improve the overall returns on your investments. A couple able to invest their combined allowance (currently £10,680 each) each year could amass almost £300,000 in 10 years, assuming 4% annual growth and no rise in the annual allowance.

Dividend-paying investments are taxed 10% at source and this is not reclaimable within an ISA, but interest-paying investments such as corporate bonds and cash are truly tax-free, points out Justin Modray, founder of financial website Candid Money.

"A higher-rate taxpayer would save more than £100 a year when investing their £10,680 annual allowance in dividend-paying equity funds yielding 4%, or more than £250 if they held corporate bond funds." 

6. Consider ETFs

Exchange traded funds (ETFs) give you access to a wide range of investments at low cost. Their 'passive' approach makes them similar to tracker funds, but the difference is that they are traded on an exchange, like a share.

There are plenty of ETFs to choose from and a variety of ways that they can be constructed. Modray says: "As they're traded on the stock exchange you'll have to pay stockbroker dealing fees, but there's no stamp duty. These products can be an attractive alternative to more expensive actively-managed funds."

7. Embrace pound cost averaging

Regular monthly investment - paying a set amount each month to buy units of a fund at whatever price they are available - can make a lot of sense. "If you regularly invest £200 into a fund and have been buying units at £8 each, when the price falls to £6 you will get more units for your money," explains Darius McDermott, managing director of Chelsea Financial Services.

When markets are volatile, you're likely to end up with more units bought at a lower average price than a lump sum investor, which is known as pound cost averaging. Regular saving also takes the guesswork out of timing your investment.

Conversely, there may be occasions when it pays to invest a lump sum, as you can sometimes benefit from lower charges, but this must be balanced against the risk of investing before a market fall.

8. Consider multi-asset funds

Buying and selling funds incurs costs, and so you will save money if you select funds you can hold for the long term, argues Connolly.

"The best way to do this is to select a fund that invests in a wide range of different investments including shares, fixed interest and property, with the relative balances adjusted by the manager as circumestances change," he says. "A good choice is Cazenove Multi Manager Diversity."

These funds have an added bonus. As no single asset class can be guaranteed to top the performance charts every year, exposure to a broad mix of investments means you are less vulnerable to a fall: when one is going down, others are hopefully thriving.

9. Be wary of multi-manager funds

The idea behind multi-manager funds is pretty compelling. You buy into an investment fund whose manager buys a range of other funds, rather than individual shares. The benefits are that you have a ready-made fund portfolio and also increase your chances of success by tapping into the expertise of specialists in various areas.

The downside, however, is that you will be paying an extra level of charges because you have two sets of manager fees.

"These funds do have a role to play but if they have total annual costs of more than 2% then they have to perform very well to justify the high charges," Connolly says.

10. Keep an eye on other fees

There's a good chance your existing investment funds are paying around 0.5% annual trail commission to either a financial adviser or a fund supermarket, according to Modray.

"If you don't need advice then change the 'agency' on the funds to a good discount broker who will rebate this commission to you," he says. "Cavendish Online is currently the cheapest, rebating all trail commission in exchange for a one-off £25 fee."

Separately, more investment funds are being launched with performance fees built in on returns above a certain level, as well as set annual charges.

Performance fees are heavily used in Absolute Return funds, where some managers set themselves low hurdle rates so they can earn performance fees for achieving modest returns.


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