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.”