Investment Costs – What is the ‘Real Deal’?


We have visited this subject many times, but make no apology for doing so again. If you currently have investments in Unit Trusts, Stocks & Shares ISAs or Pensions, or are planning to do so, then reading this article could save you a small fortune over, say, 10 – 20 years.

Let’s take a look at the typical costs you are faced with when you invest your money:

Initial Costs

This is the percentage of the investment that you pay up front and is taken from the product you are investing in.

If you are using a Financial Adviser, we believe that the maximum percentage you should pay is 4% of the amount you are investing, with a sliding scale down to 1% for larger sums, regardless of which type of ‘product’ (pension, ISA, etc) you are investing in.

Ongoing Annual Costs

These are not just the Annual Management Charge (AMC), typically 1.5%, but since there are also other administrative costs such as trustee fees, legal and auditors costs etc, the figure to illustrate these is known as a Total Expense Ratio (TER). This can be, say, another 0.2%, and so you would think that the overall annual cost is therefore 1.7%.

However, there is a missing cost which can double or even treble (or more) this amount, and it is very unlikely you would ever know about it, as the information tends to be buried in the paperwork you receive.

These are costs that the fund incurs for trading – buying and selling stocks – known as Portfolio Transaction Costs (PTC), OR Portfolio Turnover Rate (PTR) and they are not included in the TER.

The more active a fund manager is buying and selling stocks, the higher will be the costs incurred. They include:

  1. Cost of Commissions – Stockbroker’s charges for executing and then clearing a trade
  2. Spread Costs – The bid / offer spread is the difference between the prices at which shares can be sold and bought
  3. Market Impact Costs – Costs which are incurred when the price changes as a result of the effort to buy or sell that stock
  4. Cost of Tax – In the UK there is stamp duty to be paid with trading
  5. Opportunity Costs – This is the cost of a delayed or missed trade

One of the amazing things we find is that not only do investors not know about these extra costs that have an impact on the returns you will receive, but some financial advisers do not know about them either!

If you have an adviser, make sure you ask them what the Portfolio Turnover Rate is on your funds.

So, how can you find out about these extra costs? Well, they are in the fund’s prospectus, and will show for the previous year what percentage of fund assets were traded. The FSA estimates that a 100% fund turnover in an equity fund in a year would cost the fund around 1.8 per cent. However, on a Fixed interest fund, costs tend to be much lower.

Latest calculations from Financial Express Data has shown that the average UK Equity fund to February 2009 showed a figure of 95% fund turnover, meaning that these trading costs would add circa 1.7% to the annual costs of the funds.

It should be noted that in some markets, such as Emerging or Far East funds for example, the PTR rate can add much higher costs than this, even as high as 9%. So why are these costs so important to know about? Very simply they bring ‘performance drag’ to the way your money grows. Let’s add these costs up:

AMC – 1.5%

TER – 0.2% (say)

PTR – 1.7%

Total – 3.4% pa

So, your fund will have to perform at 3.4% pa to even stand still!

That is one of the main reasons why there has been a lot more interest in index and passive funds, which have much lower PTRs, and usually lower costs generally.

So how would the costs look on a typical passive equity portfolio? We presume here that you would like guidance and advice on your investments, and use a fee based wealth manager & planner who will look at all your requirements, and have £150,000 to invest or transfer.

You might expect that this would be at least the same in costs,if not more?

Well, they should look something like this:

AMC – 0.4%

TER – 0.2% (say)

Admin – 0.55%

PTR – 0.2%

Fee – 1.0% (financial Planner)

Total – 2.35% pa

As you can see, this service should work out with less costs, but deliver far far more to you, the client. As mentioned in previous articles, this includes advice such as why not spend more or pay off debt etc.

When you perhaps read other articles on investing, costs are mentioned, but the greatest emphasis is on performance. You will see adverts in the press no doubt boasting of the last 12 months performance, or that they were ‘top quartile’ for the last two years.

They want you to buy their funds because they ‘outperform the market’. However, as academic research constantly shows, very few funds do this year in year out, and although you can LOOK BACK and see a few funds that have done this out of thousands, try to do this LOOKING AHEAD!

As Ron Ross, Ph.D., writer of ‘The Unbeatable Market’ said – “Active [investment] management is little more than a gigantic con game”.

We feel that an adviser who is able to give you access to funds with lower overall costs, and is able to deliver a better investment experience on a sustainable basis should be rewarded for this.

Invariably, we can also tell a new client the growth rate they need on their investments to achieve their goals that they have identified with us. Nine times out of ten we can reduce the risks they are currently taking, as the financial map we create gives us this capacity. We believe achieving your goals whilst taking the MINIMUM risk is a very sensible approach.

As an example of how ‘performance drag’ can affect the returns you experience, a fund with costs that are, say, 1.5% per annum lower over 20 years, and using a 7% gross projected growth rate, you would find that the resulting fund would be around 30% higher.

The Financial Tips Bottom Line

Costs are a huge part of what you need to consider when investing your money. Make sure you, or the adviser you are using, conduct full research so that you can make a fully informed decision.

Nearly 100% of new clients we meet have these expensive active funds. Learn about the Passive alternative for a better investment experience and your peace of mind.


Look at your investments – do you know the costs you are paying that will reduce your returns?

Source by Ray Prince

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