Performance is not everything when selecting a fund. By Nic Cicutti
ANY INVESTOR trying to decide between different funds knows that performance is a key issue to monitor. In the case of with-profits bonds the way this is "measured" is by reference to bonus rates added each year, plus a terminal bonus paid when the bond is encashed.

What is not always understood, however, is that there is another critical factor to consider when choosing between different funds - the charge, often heavy, levied on the money you invest.

The first thing to look out for is a "bid-offer spread". This is an initial charge of 5 to 6 per cent levied on your investment. This means that if you were to encash a with-profits bond immediately after buying it, the amount you would get back (the bid price) would be 5 to 6 per cent less than the amount you paid (the offer). Nearly all this money is paid as commission to the adviser who sold it.

Companies try to avoid customers' natural objection to this instant depreciation by foregoing the initial charge. They impose an "allocation rate" instead which, remarkably, has the same effect as a 5 per cent charge.

Even where a company doesn't levy an initial charge, or its allocation rate is a good one, that doesn't mean investors escape lightly. There are still "management costs" which companies reflect in reduced annual bonuses.

Again, it is worth noting that 0.5 per cent of any annual management costs are accounted for by the "renewal" commission paid to advisers who sell the bonds on providers' behalf.

So how does one measure the effect of charges? One way is by making use of a requirement of all financial services that they show the effect of their charges on the annual performance of a fund.

This is done by reference to a notional 7.5 per cent assumed annual growth. So, for example, a fund's "yield" which reduces by 1.1 per cent a year because of the overall effect of charges will pay out 6.4 per cent.

Complicated enough? There's more. Some firms will also levy an early exit charge. This sliding scale of fees must be paid where a bond is cashed in over the first five years. For example, at Scottish Mutual and NPI, they can be as high as 9 per cent in year one, falling to nothing after five years. Stay away from funds with exit fees if you might encash before that.

You can cut the cost of charges by going to a broker which rebates back part or all of that initial 5 to 6 per cent initial commission. In many cases, the commission is ploughed back into the policy, increasing its value. Instead, he will receive just the 0.5 per cent renewal fee mentioned earlier.

The effect of this foregone commission can be staggering. For example, research by the With-Profits Bond Shop, which operates this method, shows that over the five years to 31 December 1998, returns on Prudential's with-profits bond were 9.6 per cent a year. But by adding the commission to their policies, investors achieved compound growth of 10.5 per cent.

The lesson is: never accept at face value the charges which you are told will be levied on your investment.

The Independent has produced a free 24-page Guide to With-Profits Bonds. Written by Nic Cicutti, personal finance editor, the guide examines the pros and cons of investing in bonds. For your free copy, sponsored by the With-Profits Bonds Shop, call 0845 2711007. Apologies to the many readers who tried and failed to obtain a copy last week