Picking the best and most suitable investments, be they shares or funds, is a challenge in itself but ensuring you are not paying an arm and a leg in charges can be a whole other task.
For festive reasons, some of us may not remember New Year's Eve 2012, but it ushered in a huge overhaul of the UK's investment industry when the City regulator introduced new legislation, called the Retail Distribution Review (RDR).
Its primary goal was to make the cost of investing more transparent by eradicating the practice of product providers paying financial advisers commission for recommending their products, a situation which was often exploited by unscrupulous intermediaries.
Now investors have to pay upfront for advice, either via a percentage fee or an hourly rate, averaging around £150. While the intentions were good, the move has arguably made the complexity of investing more intricate for consumers.
Getting down to the true cost of investing can mean labouring through a minefield of jargon. But paying too much for the privilege of investing can seriously erode your returns.
Justin Modray, founder of comparefundplatforms.com, a specialist website that analyses the costs of investing, says: "It is vital to look at the bottom line, especially if you use an adviser, discount broker and/or fund platform. Focus on how much you will end up paying after all fund charges, fees, discounts and rebates. You may be surprised: some services that purport to be cheap are actually pretty expensive. If you are opting to get advice, do not be afraid to shop around until you find one you can trust and make sure they are independent."
The costs incurred by using a financial adviser will ultimately depend on what deal you will come to with them and how much help you need. You can check unbiased.co.uk to find an adviser in your area and bear in mind many good advisers will be happy to offer a free initial consultation.
Here's what you need to know and what you should expect to pay when it comes to investing.
Initial charges are quoted for funds and are generally around 5%. They represent the one-off upfront cost of investing but it can be avoided by not buying direct from the fund manager. Discount brokers and fund platforms typically rebate commissions to investors, reducing the initial charge to zero.
Annual Management Charge
For an actively managed fund, where a fund manager selects individual stocks on your behalf, the average Annual Management Charge (AMC) is between 1.5% and 1.75%. A discount broker or fund platform may help you shave some of this off, too. There are now two types of charging following the implementation of the RDR: funds that still include commissions and platform (fund supermarket) fees called 'retail' versions; and those that do not, known as 'clean' versions.
Clean versions typically charge around 0.75% less, therefore annual charges tend to be around 0.75% and 1%.
Total Expense Ratio (TER)
This is the bottom-line fee for any fund investor to take note of. The TER, sometimes referred to as an 'ongoing charge' includes the annual management charge as well as other 'hidden' costs such as dealing and regulatory fees, incurred by a fund, which can add 0.1% to 0.2% or more to the overall annual cost.
These are an extra layer of charging investors can be hit with after a fund delivers a sufficient level of positive returns to its investors, but they are not very common among retail funds.
Shares and funds
You can buy and sell shares via a stockbroker. These days, deals are usually made online but they can be made over the phone, even though the latter option costs more. Trading online means you can view your portfolio whenever you wish and there are even apps that allow you to trade on the go.
Costs vary between brokers, averaging around £10 for each UK trade. If you wish to buy individual stocks from further afield, such as shares in Apple, which is listed on the US Nasdaq stock exchange, the trading costs will rise to between £15 and £20. Avoid stockbrokers that charge a percentage, as opposed to a fee, particularly if you have a smaller portfolio.
Most online sharedealers sell shares on a 'nominee' basis. This means shares are held on your behalf by your provider. While this means you won't get a share certificate, it does reduce your costs. In addition, find out how much it costs to re-invest dividends - profits shared out by companies to shareholders. Some low-cost brokers charge their usual dealing fee for reinvesting while others offer a discounted rate.
Finding the best-value stockbroker largely depends on how often you trade. If you only trade a few times a year, then avoid quarterly account fees. Some brokers also have 'inactivity charges' if your trading activity is sparse.
When you invest in a fund, your money is combined with that of other investors and used to purchase a spread of different investments by a fund manager. Active fund managers pick stocks in a bid to beat a particular market, such as the FTSE 100; while other cheaper funds, known as index trackers, slavishly follow an index.
Investors need to pay attention to two specific types of charges when investing in a fund, the 'initial charge' and the annual cost or TER.
Never buy direct from the fund manager, as upfront charges can be high. But you should not expect to pay an initial charge these days.
Tracker funds can be had for as little as around 0.2% a year while actively managed funds tend to be around 0.75% to 1% a year for 'clean' versions. But to get these low charges, you have to buy via a fund platform or discount broker, the most popular options for investors.
The price of investing through these portals can depend on what funds you are invested in. Alliance Trust Savings, Sippdeal and Cavendish Online tend to be among the most competitive for direct and ISA holdings. Alliance charges £48 a year and Sippdeal £50 a year while giving access to lower-cost, clean fund versions. Cavendish Online uses retail versions but rebates all commissions, which means most actively managed funds come out at around 1% a year.
Investment trusts and ETFs
As with funds, when you invest in an investment trust, you pool your cash with other investors to purchase a wide range of stocks. Investment trusts have never paid sales commissions, so do not levy initial charges.
Like shares, they are traded on the stockmarket so a low-cost broker such as SVS Securities is the cheaper route, though costs will incur stamp duty.
Ongoing charges can vary from 0.3% to more than 1.5%, depending on the size of the trust and how the fund is investing.
According to the Association of Investment Companies, the average equity portfolio's 'ongoing charge' is 1.21%. Some investment trusts charge a performance fee, too. You can see a full list of charges at theaic.co.uk.
Exchange traded funds (ETFs) are just like tracker funds in that they mirror the movements of a particular market or index such as the FTSE All-Share - given they are not actively managed, the costs are cheaper too.
They differ from trackers in that they are listed on a stock exchange and, as such, are traded like shares, with the same cost implications - but free from stamp duty. Most ETFs charge around 0.2% to 0.6% a year depending on the index being tracked. Unlike tracker funds, ETFs do not have a monthly savings option, so if you invested regularly, on each occasion you would be paying the dealing charges, which would eat into your returns.
'Clean' pricing will benefit investors
The investment industry is currently in a state of flux. Although advisers can no longer receive commission from fund managers, execution-only operators (where no advice is given) such as discount brokers, and fund platforms may still do so until April next year, when a new tranche of regulation arrives - the so-called 'Platform Paper'.
Currently, investors usually just see a headline fee when they invest in funds via an execution-only service; they do not, however, know how the fee they pay is split between the fund provider and the broker. But the incoming rules will force execution-only services to disclose the breakdown between what they are taking and what the fund provider is receiving, known as 'clean' pricing.
This increased transparency should hopefully mean a better deal for investors as it should force broker costs to become more competitive and levy smaller costs on investors. You can compare investment costs via a calculator at trueandfair.com.