Keeping your investment costs low

The array of funds available to invest in can be confusing, even for professionals. In many places funds are still sold in return for commission, so how can you be sure that the funds being recommended are in your best interests? This is our guide on things to look out for to help you make an informed decision.

Fund managers often create multiple 'share classes' of the same fund, each with different fees. The cheaper options are for larger investors such as other fund managers, whilst 'retail' investors, or end users, usually pay more. It's the retail sector where hidden incentives for advisors exist, making funds more expensive and reducing returns.

2013 saw the introduction of the Retail Distribution Review (RDR) in the UK. Advisors had to move away from commission-based sales and instead, provide clarity over how they charged clients. Many overseas markets are still years away from RDR type regulation, exposing investors to higher charges.

Back-end loaded funds

'Clean' share classes are usually cheapest and least restrictive, ie; free to enter and exit with lower running costs. Others have upfront fees which are visible to customers while some offer trail payments to advisors through increased running costs.

A less obvious way of paying commission is 'back-end loaded' funds, which are free to enter but incur exit charges before a specified period, often 5 years. Advisors receive a 4% commission, funded by exit fees that start at 5% for withdrawals in year 1, reducing by 1% per annum to zero after 5 years. So, selling a $100,000 fund purchase in the third year would incur a $3,000 penalty deducted from the proceeds.

Fund fees are a crucial consideration as published annual management charges (AMC) don't always show the full costs. It is the 'total expense ratio' (TER) and 'ongoing charge figure' (OCF) that matter as these also include any fees paid to advisors and show more accurately how returns will be affected.

So why pay more for the same fund, strategy and risk as other investors but with lower returns? Buying power can be a factor as you'd pay less if you have $1,000,000 than if you have $5,000. However, there are generally cheaper options for all investors to choose from and seeking advice on fund selection can help you avoid paying more than you need to.

Below are examples of the different share classes of one fund, GAM Asset Management's Star Balanced Fund with the OCF's boxed in red.  (source Trustnet).

The costs vary from 1.3% to 3.09% per annum, making the latter 237% more expensive. The graph below shows contrasts in performance between 3 of the share classes over a 3 year period. The difference between 'Z' and 'C' in the first year is 1.8%, rising to a huge 6.6% over 3 years, creating differences in annualised returns of between 6.13% and 8.33%, or 2.2% per annum. (Source Trustnet)

Investing $100,000 over 10 years would create contrasting returns of $181,293 and $222,580 respectively, a difference of $41,287 which is increased further if initial charges were paid on entry. So it's clear why advice can be so valuable. 

The best results are often achieved by using 'passive' investments and avoiding fund managers altogether. Our page on investment costs explains how to reduce fund charges by over 90%, making a huge difference to your returns.  

To learn more about keeping your fund and product costs down and improving results, contact us today and you'll get the expert help you need.

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