Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
The true cost of investing in funds
The simple act of buying an investment fund may be relatively straightforward, but working out how much it costs can be fiendishly complicated. The cost may be different depending on where you buy it, when you buy it and whether someone advised you to buy it.
Initially, there is the price an investor pays for the fund itself. This is the cost of paying a fund manager to run the fund, pick the right shares or other assets and administration, but this can be expressed in a number of different ways.
1. ‘Annual management charge’ vs ‘Ongoing charge’
All groups will quote an annual management charge. In theory, it is the charge that the investment manager levies for managing the fund. Sadly the calculation is not uniform.
One fund group may include the cost of paying a fund manager to pick stocks, plus any trading costs, administration and custody. Another may only include the cost of the fund manager with another 0.2%-0.3% on top for those extra activities. In most cases, the average investor will have no way of knowing without burrowing into the accounts.
Daniel Godfrey, co-founder of The People’s Trust and former CEO of the Investment Management Association, says: ‘The spectrum between funds with an all-inclusive charge and those with just the management fee is quite wide.
‘As such, the consumer really needs to look at the “ongoing charge” figure, rather than assuming the annual management charge is the costs they are paying. The ongoing charge figure makes all funds comparable.’
The ongoing charge figure, previously known as the total expense ratio, should give a complete picture of the fund manager costs for the fund. This is now widely quoted by all the major fund management groups on their fund factsheets.
2. Performance fees and new share classes
Some funds will impose a performance fee if the fund manager beats a pre-stated benchmark by a certain level.
Another thing to note is that funds have different share classes, typically each with different charges.
The old share classes used to bundle all costs together – platform, adviser and fund manager – and would often have an initial charge.
New share classes only have the fund manager fee. In general, if the charge is 0.65%-0.75%, you’re in a new share class. If you are paying more than that, it may be an old share class and you should think about swapping to the new share class.
3. Costs can depend on whether you made the investment yourself or through an adviser
Graham Bentley, founder and managing director of investment marketing consultancy gbi², says: ‘If someone goes through some kind of intermediation process, there will be additional costs.
‘They may go through a financial adviser who in turn will use a platform to buy and sell investments. In this case, the fees may look something like: 0.85% ongoing charge for the fund manager, 0.35% to the platform and a further 0.5% to the financial adviser.’
Those investors who use a direct platform with no advice such as AJ Bell Youinvest will only pay the platform fee and the fund management fee. Some platforms may charge additional fees for closing accounts, transfers or for issuing paper statements.
Bentley says that only by adding the ongoing charge, the platform charge and the financial adviser charge (if applicable) can investors get to a ‘total cost of ownership’ figure.
4. Where to find information on charges
You should look at a fund’s factsheet for the ongoing charge, the platform website for its fees and, if using one, the financial adviser for their fees.
Equally, while it is possible to compare the fund management costs, it is not always easy to compare platform costs or the costs of financial advisers, says Bentley. ‘In general, if a financial adviser is cheap, people don’t know.’
Fees are often taken from the investment (usually monthly) and it can be difficult to disaggregate them from investment returns, dividends and monthly savings.
Does it matter? After all, on a £1,000 investment the difference between a 0.75% and 1% fee is not that great – just £25 – and £25 won’t do much in retirement. The problem is that higher fees are magnified over time. Compound interest is a potent way to build wealth over time and fees can take a chunk of that amount.
5. Fees can depend on the type of fund in which you invest
Fund management costs will vary, most notably between active funds and ETFs or tracker funds, but also between active funds as well.
Larger funds will often be able to achieve economies of scale (though this doesn’t necessarily make them better).
Investors will often pay a little more for certain strategies such as emerging markets or smaller companies.
Platform charges will also vary considerably. Some platforms will charge fixed fees, which may suit those with larger portfolios better than a percentage fee of assets under management.
Financial regulator the FCA is planning a shake-up of asset management fees. However, previous regulatory shake-ups have generally done little to simplify charging, and in some cases have done the opposite.
For investors, the unwelcome answer is simply to be alert to the different costs and check you aren’t overpaying at any link in the chain. (CR)