It pays to keep an eye on fund fees

Our team of experts warn management charges can make a serious dent in your investment.

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When you look at how an investment has performed, it's very easy to focus solely on how much it has generated – but equally important is keeping an eye on the associated costs because these can easily wipe out any profit that has been made.

Andy Gadd, head of research at Lighthouse Group, believes this means fees being levied must be closely scrutinised because of the impact they can have over both the short and long term.

"Without the aid of a crystal ball it's impossible to be certain about the future performance of an investment fund, but charges are broadly known at the outset, so should be an important consideration when choosing investments as it's important not to overpay," he said.

For example, if you invested £10,000 over 20 years, enjoying an annual return of five per cent, you would end up with an impressive £19,898, he points out. However, when you factor in annual fees of 1.5 per cent your total will be reduced by a staggering £6,635.

So where should investors start? How can they ensure they are not spending money needlessly? We have teamed up with a number of independent financial advisers and economic commentators to compile a list of seven ways to cut the cost of investing.

1. Do you need active fund management?

Should you invest your money in relatively cheap, passive investment strategies or pay more for the services of an active fund manager in the hope that their expertise will help generate better returns? It's a pressing question and unfortunately there's no easy answer.

As the name suggests, tracker funds attempt to replicate an index, such as the FTSE 100, rather than trying to beat it, with the main advantage being that this can be done at a much lower cost than an actively managed fund – around 0.5 per cent instead of 1.5 per cent.

However, paying whopping fees to so-called active managers doesn't guarantee a better return, according to Justin Modray, founder of website Candid Money. In fact, tracker funds can often outperform.

"Many highly paid active fund managers fail to beat the index, so choosing a low-cost tracker fund might leave you better off overall," he said. "However, it's not clear cut, so hedging your bets by combining the two within your overall portfolio often makes sense."

2. Keep tabs on fund charges

If you are buying an investment fund you need to think of them in asimilar way to products from retailers and shop around to compare the prices. Not only do fees vary – even between similar funds – but it can also be very difficult to understand the various charging structures in place, points out Geoff Penrice, an independent financial adviser with Honister Partners.

"You will have the annual management charge (AMC), which can often be between one and 1.5 per cent for an active fund, as well as a range of other costs," he said. "When the AMC is combined with other charges it is known as the total expense ratio, which is also expressed as the TER."

Further complicating matters is the fact there may well be dealing charges on top of the TER. This means that the more actively a fund is managed, the higher the dealing charges.

In addition to the initial and annual charges, an increasing number of funds are being launched with performance fees as well. These are supposed to reward outstanding performance but you need to examine the terms carefully, warns Patrick Connolly, head of communications at AWD Chase de Vere.

"They are particularly heavily used with absolute return funds where some fund managers set themselves very low hurdle rates so they can reward themselves amply with performance fees for achieving returns very similar to those available from cash accounts," he said.

However, although charges will impact on the performance of a fund, it is not fair to assume a lower-charging fund will outperform one with higher fees. A well-run, high-charging fund may give much better returns than a poorly run, cheaper fund.

3. Use a fund supermarket

A fund supermarket allows your funds to be held on a single trading platform. This can make it far easier to keep track of your investments – as well as being more convenient, according to Mr Connolly.

"Using a fund supermarket allows you to select from a wide range of funds," he said. "You may get a cheaper deal when investing through one and any subsequent fund switches should be quicker and more cost effective."

But there are still potential dangers, warns Mr Gadd. "Costs can be reduced by purchasing investments throughvarious discount sites, but it's important to understand a good financial plan does not simply involve purchasing funds but ensuring that investments match an individual's aims and objectives and capacity for loss," he said.

4. Embrace pound cost averaging

A sensible method of investing is to put money away monthly, suggests Darius McDermott, managing director of Chelsea Financial Services. This is known as pound cost averaging and sees investors paying a set amount each month to buy units of a fund – at whatever price they are available.

"If you regularly invest £200 and have been buying units at £8 each, when they fall to £6 you will get more units for your money," he explained. "As well as providing an averaging effect, it's a great savings discipline."

It can also save you time, according to Jason Witcombe, a chartered financial planner with Evolve.

"If you set up a monthly direct debit into your individual savings account (ISA) rather than investing up to £11,280 all in one go, you are turning a big decision into a small one," he said. "The more aspects of your finances you can put into 'auto-pilot' the better."

There may be occasions when it pays to put in a lump sum as you can sometimes benefit from lower charges, but this must be balanced against the risk of investing at the wrong time.

5. Make sure your investments are tax efficient

You may consider taxation a necessary evil – which, in many cases, it is – but there are ways to lessen the impact it will have on your overall investment returns. Perhaps the most obvious way is by utilising your full annual individual savings account alliance.

This has recently risen, meaning that you can invest £11,280 in the current tax year – half of which can be in a Cash ISA, points out Geoff Penrice at Honister Partners.

"Although this figure may not seem very high, if a couple each use their allowance over a 10-year period they could easily end up with more than £250,000 in ISAs," he said. "The tax advantages then appear very meaningful."

6. Shop around for a stockbroker

If you are opting for individual shares rather than investment funds you would be advised to shop around for a suitable stockbroker as each will have their own charging structures. Some will demand a fixed fee while others will base the fees on a percentage. Therefore it is important to have an idea of what amounts you want to invest and how often you plan to deal.

Deciding the level of service required is also important, said Mr Modray. For example, discretionary arrangements enable the stockbroker to move the investment on behalf of their client, while advisory involves making recommendations. The execution-only services, meanwhile, sees the stockbroker acting on their client's instructions.

"You can find brokers that enable you to buy and sell shares for around £6-a-trade whereas some will charge more than £50," he said. "The advice is that when you are trading online the service you receive won't vary much so you may as well shop around for the cheapest deals."

7. Consider other investment vehicles

Unit trusts may be the most popular form of investment funds but it can be worthwhile looking at other options as well, according to Andy Merricks, head of investments at Skerritt Consultants.

"Some unit trusts have a mirror investment trust which will almost always be cheaper," he said. "I have used them and there's certainly a place for them in portfolios."

You may also want to consider exchange traded funds (ETFs) which have grown in popularity over the past decade. These products provide access to a wide range of different investments – including indices and physical assets – at low cost.

Their "passive" approach makes them similar to tracker funds, but the difference is that they are traded on an exchange like a share. "ETFs have given us a low cost option for investing in all sorts of areas," added Mr Merricks.

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