Double your money the painless way

How can you can beat that poor 2 per cent return? asks Jamie Felix. You just cut costs

Stock markets are surging again, but that does not mean investors are pocketing the profits. The typical shareholder might net only a measly 2 per cent profit this year, after the effects of commissions, taxes and inflation are taken into account. But research has found the extent to which you can improve your return by keeping costs down.

Stock markets are surging again, but that does not mean investors are pocketing the profits. The typical shareholder might net only a measly 2 per cent profit this year, after the effects of commissions, taxes and inflation are taken into account. But research has found the extent to which you can improve your return by keeping costs down.

As the tables below show, raw investment returns are only the first step towards long-term profits, and it pays to keep an eye on your bottom line.

Most analysts are predicting shares will produce a steady but unspectacular performance in 2004, with average gains of 6 to 7 per cent. But those returns look a lot lower, after the broker and the Government take their slices.

Assume you have a lump sum of £3,000, which you invest in a pool of equities through your bank's online share-dealing service. NatWest charges a flat 1.75 per cent trading commission on purchases under £5,000 (minimum £25), plus a further 0.5 per cent stamp duty. So 2.25 per cent is surrendered up front, and that takes no account of additional trades during the year.

Up-front fees have a double-whammy effect on returns: they eat up a chunk of cash, and they reduce the value of your initial investment, so there is less money at work for you in future. Your £3,000 is actually £2,932.50 (£3,000 less £67.50) after these trading fees.

Assuming the market behaves as the experts forecast, and your investments increase 6 per cent in value this year. Your £2,932.50 will grow to £3,108.45, a net increase of £108.45. But the Revenue wants its piece of the pie. You are allowed up to £7,900 in capital gains tax-free, then the profits are treated as income. For higher-rate taxpayers, that takes 40 per cent of any additional profit.

If £108.45 was your only investment gain for the year, then you are in the clear as far as capital gains tax is concerned. But if you exceeded your annual allowance (perhaps you made a juicy profit on the sale of a second property, for example) then that is £43.38 more trimmed off, leaving you with net profits of just £65.07.

Finally, there is inflation. The Government expects that to continue at 2.5 per cent, so in real terms, your £65.07 will be worth only £63.44. Now, £63.44 leaves you with nowhere near the 6 per cent return you started with. All those fees, taxes and inflation mean you are gaining only 2 per cent on your initial £3,000.

At that rate, it will take 33 years to double your money in real terms, and that assumes the market continues to climb steadily, the rate of inflation does not increase, and you re-invest all your profits year after year. Even a slight slip in the growth rate, from 6 per cent to 5 per cent, would mean a further 12 years to double your cash.

If waiting until 2037 to double your money is none too thrilling, there are ways to reduce your expenses and keep more of what was yours to begin with. You could take advantage of tax-efficient Isas and pension products to shelter your gains from the tax man. Investing through a discount share-dealing service will cut your fees on buying and selling shares.

Investment clubs are another popular alternative to help cut trading costs. By pooling your money with a group of other investors, the commission burden is shared. If a club with six members splits the 2.25 per cent share-dealing fees, the cost is slashed to just 0.375 per cent per person.

And instead of trying to beat the market, why not join it and save a pile on your investment costs as well? Putting your cash in a low-cost tracker can give you a broader exposure to the whole market for a fraction of the price of buying the same set of shares yourself.

The Liontrust FTSE 100 tracker charges no initial fee and has a 0.30 per cent annual charge, 1.95 per cent less than the 2.25 per cent cost of buying your own shares in our previous example. Compounded over time, an extra 1.95 per cent a year can really boost your portfolio performance, as our chart shows. Growing at 2 per cent, your money will increase 49 per cent in value over 20 years. At 4 per cent, it will climb 119 per cent. Buying your investments through a tax-efficient Isa can further improve your results, particularly if you are liable for capital gains tax.

Make those two changes, and your real return after inflation would jump from a sickly 2 per cent to 5.6 per cent. At that rate, you will double your money in 13 years rather than 33.

But not all tracker funds are created equal, and it pays to do your homework. Annual charges vary widely, although they should be lower than those levied by actively managed funds. You should never pay an initial charge to purchase a tracker fund, Justin Modray of BestInvest, an independent asset manager, says.

He recommends the Legal & General FTSE All Share index tracker, with no initial fee and an annual charge of 0.5 per cent. The fund tracks an index of the UK's top 350 UK shares, offering wider exposure and more variety than a FTSE 100 tracker. Mr Modray says: "Nearly three-quarters of the FTSE 100 is accounted for by the largest 20 companies in the index. By comparison, the All Share index holds just 55 to 60 per cent in the top 20 shares, giving investors more opportunity and exposure to the mid-cap range of companies."

'I resented paying fees'

James King, a semi-retired business consultant from Cambridge, operates his own investment portfolio. "I resented paying a fund manager to lose my money for me," he says. "Using a discount broker has significantly cut my investing costs."

Mr King makes about 15 trades a year on the TD Waterhouse website, for a flat £12.50 per trade, an annual total of £188, or just 0.35 per cent of Mr King's £60,000 portfolio.

He also has a Virgin Money index tracker, with an annual management fee of 1 per cent.

CONTACTS

* You can compare charges on more than 100 share-dealing accounts at www.moneysupermarket.co.uk. Enter your investment amount and the website will calculate your annual costs with a variety of share dealers.