Know your charges: the costs of investing
If you want an expert to manage your money, be that a fund manager, a discretionary manager or a stockbroker, they will charge a fee for their services. But even for DIY investors there will be dealing and platform costs of which they have to be aware.
The impact of costs
It is easy to dismiss the odd small dealing cost here or there, but investors shouldn’t forget the effect of compounding. If you invest £250 per month for five years with an average return of 5 per cent per year, your pot will be worth £17,073 at the end. If you lose £10 per month in costs, it will drop to £16,342; if you lose £20, it will drop to £15,661.
The effect is greater the longer you invest. Costs can make a meaningful difference to your return over the long term.
All collective funds have a charge. For passive funds, because there is no fund manager in charge, the costs are generally lower. For active funds – those where a fund manager selects the best stocks – the fees will be higher.
Management fees are not uniform, and will be higher for an equity fund over a bond fund, and higher for a complex equity fund (such as one invested in emerging markets) over a more standard equity fund (such as one invested in the UK or US).
Open-ended funds (OEIC or unit trusts) and closed-ended funds (investment trusts) are bought and sold in different ways. Investment trusts are shares and therefore investors will usually pay a one-off dealing cost to buy them, which they don’t for open-ended funds.
Brokers and platforms will charge a certain price per deal, which they may reduce for regular trading, others will charge a flat annual fee, and you can do as many trades as you like. If you are a regular saver, the key is to ensure that you are not paying a dealing cost every time.
Platform charges – where it gets complicated
In the old days, platforms such as Hargreaves Lansdown and Fidelity operated on a system whereby fund managers would give them a rebate on the annual management fee of a fund for ‘shelf space’. A fund with an initial charge of 5 per cent may give 4 per cent back to the platform. The platform would then give part of this back to the investor in the form of a ‘rebate’. This would either be in cash or in units of the fund. This has now been phased out and new ‘unbundled’ share classes are being launched where investors just pay the management fee for the fund provider.
Tax wrapper fee
Some platforms charge explicitly for tax wrappers such as Isas or Sipps. The best charging structure will depend on the type of investments held within an Isa or personal pension, but it is worth shopping around. For example, if you buy and sell funds frequently in your Isa, a flat fee may be better. If you are a buy and hold investor, there may be fewer advantages to a flat fee structure. If you have a very big portfolio, a flat fee may be better than a percentage of assets.
Cost of advice
The cost of your financial adviser will sit on top of any cost of investments or tax wrappers. This now has to be explicit rather than being wrapped up in any product charges. Most advisers will either charge a flat upfront fee, or a percentage of assets under management. Increasingly, however, more innovative charging structures, such as monthly retainers are emerging.
The hidden wrinkles
-Be careful how you are charged for reinvestment of dividends. This can add up if you are being charged a flat fee every time for the reinvestment of relatively small dividend payments.
– Be careful on regular savings. Make sure you are not being charged every time you invest.
– Shop around. Platforms vary significantly in the way they charge and investors need to find the structure that is right for them.
– Be careful on investment trusts. Some platforms are not well set up to deal with them and investors can accidentally incur high charges.