The cost of investing: five things you need to know.
The fees you pay when investing can make a big difference to what you might get back over the longer term. If you want to maximise your return potential, it’s important to factor all costswhen making decisions.
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Fees may be the least interesting aspect of investing. It’s a little like buying a tin of beans and focusing on how much you pay for the tin. However, that doesn’t mean you can ignore the charges you pay; especially as it can have a meaningful impact on your long-term savings plans.
Here are five things you need to know about the charges you pay to those managing and administering your investments:
1. High costs are magnified over time
If you invest £100,000 over 20 years at a rate of 5%, you’ll have a tidy £271,000 at the end of it. However, if you paid an extra 1% a year in fees, you’d see around £50,000 wiped off your overall return.
You may hope that paying higher fees would give you a better return – much in the same way that an expensive suit is better quality – but there is little real evidence of this happening in practice. The fees of active investment funds tend to cluster at around 0.75% per year and there is no guarantee that expensive funds will perform better than average.
2. The Ongoing Charge Figure (OCF) covers most of the costs...
The OCF comprises the annual management charge (AMC) levied by the fund management group and a variety of other operating costs. These charges cover the cost of running the fund, including maintaining records, producing reports and calculating the daily unit price. If the fund manager uses external research to make buy and sell decisions, this is also included in the OCF.
3. ...but not all of them
There are also trading costs. These are the costs associated with buying and selling assets within the fund and may add another 0.1-0.2% per year over and above the OCF. The charges will be higher for funds that trade regularly and less for those that take a buy and hold approach. Active managers hope the extra returns made from successful trades will outweigh the costs involved, but this is not guaranteed.
4. There will be platform charges on top
In addition to the charge you pay for investing in the fund, the platform or stock-broker will also charge a fee. They may charge per trade, a percentage of the assets you hold on the platform, or a flat annual fee. In general, a percentage fee will suit those with smaller pots, while a flat fee may be beneficial for those with a large portfolio.
Beware of any hidden costs. Some brokers will charge a fee to move assets between platforms, so called ‘exit’ fees. Check a platform’s schedule of charges before investing.
5. Financial advice will be an additional cost
If you invest with the help of a financial adviser, they will levy a separate charge for the advice they provide. Different advisers will have different charging methodologies, it may be a lump sum, or a percentage of the assets you have under advice with them. The cost of advice varies but might be around, say, £150 an hour, or 0.5% a year of the value of your fund.
Paying attention matters
In an era of low interest rates – and after a decade-long bull market in equities and bonds, turned to bear by the Coronavirus crisis – investment returns may be lower from here. This means that it is even more important to pay attention to costs and the extent to which they eat away at your long-term returns.
Make sure you know what you’re paying; competitive costs are a route to better long-term returns.
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