If you are a private investor the primary concern is the performance of your investments, that is why all the figures quoted on 80-20 Investor are net of charges. Yet the performance of your investments can be impacted significantly by the charges levied by fund managers on an ongoing and ever increasing basis.
The headline performance of your investments will mean very little if you are paying a sizeable chunk to a company for simply managing these investments on your behalf. So what are these charges and how do you make sure they are reasonable and competitive?
When you buy unit trusts and OEICs there are two main charges levied, an initial fee and an annual fee.
Initial fee
This is a fee levied when you first invest in a fund. If you are investing in an OEIC (an open ended investment company) then this initial fee is levied as a percentage of your overall investment, typically around 5%. So, as an example if you were to invest £5,000 in a fund you would actually only be investing £4,750 after the initial fee.
If you were investing in an OEIC on a monthly basis the initial fee would be added to the cost of the shares your were investing in rather than paid upfront. Therefore the cost of shares purchased will be 5% higher than the quoted price.
If you were investing in a unit trust the initial cost would be reflected in the difference between the buying price (offer) and the selling price (bid) of the units on the day of purchase. This difference between the bid and offer price is known as the spread and is typically around 5%.
Annual management charge
This charges pays for the annual running costs of the chosen fund. This charge is typically made up of a number of different costs and is typically in the region of 1.5%.
Other costs
The transactions that fund managers undertake within funds such as the buying and selling of different assets will all incur costs. Some estimates suggest that these costs to amount to as much as 1.8% to 2% of your fund value in a single year.
How can I compare the charges between different funds?
The useful indicator to use for a comparison of charges is a measure called the ongoing charge figure (OCF) or total expense ratio (TER). This includes the AMC as well as other additional costs taken directly out of the fund, but not all of them.
Fund managers are obliged to show the ongoing charge in their fund literature and must publish this once a year. This information can be found in a document known as the Key Investor Information Document (KIID).
What is the potential impact of these charges and how can I reduce them?
The overall effect of these charges on your investments can be quite dramatic. Research carried out by the consumer organisation Which? shows that if you invested £10,000 in a fund with no charges and it grew at 6% annually for 20 years you would get a return of £32,071 - just over £22,000 growth.
If, on the other hand, you invested in a fund with the industry average ongoing charge of 1.67%, your return would be reduced to £23,344 - meaning £9,000 of your growth goes on charges. That’s without factoring in other charges such as transaction costs.
There are, however, ways in which you can reduce your costs as follows:
- Tracker funds and ETFs are much cheaper in comparison to actively managed unit trusts and OEICs
- If you want active management then investment trusts have lower TERs than unit trust and OEICs
If you are investing in unit trusts then significant savings can be made by investing through a fund supermarket or a discount broker
