Thursday, March 8, 2012

The truth about fees that every ISA investor should see

It's the time of year (less than a month to go until the 2011/12 deadline) when many people in the UK are thinking about where to invest their ISA allowance.

If you are planning to invest in a fund rather than cash or self-selected securities, then the table on the left (produced by Vanguard - see this excellent guide "The Truth About Costs")) could be more important than any research you do into which funds are likely to outperform. It shows that a fund with high charges will underperform and disappoint in the long term almost however well the fund manager does or however clever you are in selecting a "hot" investment trend.

For the average investor who doesn't follow and track these things, the effect of fund charges are greatly under-appreciated.  0.25% or 1.6% or even 2.5% don't sound very substantial numbers.  A positive bargain actually when compared with say a 15% tip at a restaurant.

The problem is that fund charges are made every year on your cumulative investment, so over a 30 year period a fund charging 2.3% (many do) will take that % of the money you invest in year one 30 times.  And they will take 2.3% of any gains and dividends.  And all the charges they make reduce your capacity to roll up cumulative gains on the investment.

Small wonder that even a 1.6% charge rate can reduce a potential "pot" of £46k to £29k even before inflation is considered and even before tax because it is in an ISA.  And don't get me started on so called Independent Financial Advisers and their fees.  Or "funds of funds" which have two layers of charges.

If you want to find the real scandal of the City, forget about hedge funds and bonuses: it's the quiet, deadly raids that are being made every day on our savings that are the real disgrace.

What to do?

Option 1 - open a self-select ISA with no annual admin charge and pick out 5 or 6 quality stocks with your allowance (perhaps spread the timing of your investments over the year - one every two months) and forget about them.  Apart from the small commission and stamp duty* at the beginning you will have no charges to pay.

Option 2 - pick funds with low charges. Look for a TER* or Total Expense Ratio and remember the difference between 0.25% and 2.5% is enormous.  Any fund with a high TER must really justify itself.

* - note that dealing costs are not included in the TER - they are taken directly out of the fund - so that actual charges are higher than the quoted TER

Final note to anyone unfamiliar with initial charges: never pay them.  Some funds charge up to 5% simply to buy into their fund.  That's money taken upfront and which never earns you any cumulative return.  It is completely unjustified - it's like being charge commission to enter a really expensive shop and spend money there.  Avoid by going to a broker which waives or rebates the charges.

From our website:  Self employment in Spain - the guide

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