Fund fees and broker fees – Don’t overpay!
Fund fees are notoriously difficult to get to grips with. In my experience there are two types of investors: Those who think they know what they are paying but don’t, and those who know they don’t know!
To be fair, lots of investors know about the ongoing charges figure (OCF), previously called the total expense ratio (TER), but this only tells half the story. There are all kinds of charges that can eat into your investment returns.
Fund fees depend on what kind of fund you invest in and which broker you use. Similar funds can have completely different fees depending on exactly what kind of fund they are. Which broker you use can also heavily influence how well your investments do.
This article makes an attempt at demystifying broker and fund fees.
Because fund fees are dependent on the type of fund in question it worth being aware of the key differences between fund varieties.
Fund Varieties
Mutual Funds, OEICS and Unit Trusts
Mutual funds are usually called open ended investment companies (OEICs) or unit trusts in the UK. OEICs are more recent than unit trusts, but they are pretty much the same thing. In fact, many unit trusts have now simply changed into OEICs.
For the purposes of this article I’ll be grouping them all together as mutual funds.
Generally, when people talk about funds in the UK, they are talking about these.
They tend to have fund managers who make active decisions rather than passively following an index.
On average they are more expensive than other types of fund.
Investment Trusts
Investment trusts are similar to mutual funds, but there are a few important differences.
Investment trusts are bought and sold on a stock exchange like individual shares.
The prices of shares in investment trusts can trade at a premium or discount to the underlying assets.
They can use leverage. Good in the good times but not so good in the bad times!
Due to leverage and the fact that investment trusts can trade at a premium or discount to their underlying assets, investment trusts are generally considered more risky than mutual funds.
Exchange Traded Funds
Exchange traded funds (ETFs) are funds that are can be traded on an exchange like investment trusts. They are usually passive/index style funds. As a result they tend to have cheaper ongoing charges than either mutual funds or investment trusts.
Shares
Why have I included shares when talking about funds you may ask?
From an investor’s point of view some Real Estate Investment Trusts (REITs) can be looked at just like shares of companies.
On the face of it you might be forgiven for thinking REITs are all the same, but they are not.
As far as I am concerned they sit in two groups. REITs run like companies, and REITs run like funds.
Generally, the ones that are run like funds have a fund manager and ongoing charges, and the ones that are run like a company don’t. No ongoing charges usually makes REITs a cheaper investments.
As an example British Land has no ongoing charges. However, a quick trip to the Association of Investment Companies (AIC) where you can compare all kinds of investment trust, will reveal lots of REITs with high ongoing charges.
Take Regional REIT for example. It charges 4.23% ongoing charges, and 5.88% when a performance fee is taken into account.
Regional REIT is going to have to outperform British Land by 5.88% just to break even with it.
The AIC lists about 40 funds focused on Real Estate with ongoing charges ranging from 0.88% to 12.89%! The average seems to be around 2%.
Broker & Fund Fees
Once you’ve decided to invest you need to decide which funds to buy and which brokerage to use.
A brokerage enables investors to buy and sell investment products such as stocks, bonds, ETFs, currency, futures and options.
There are many reasons to choose one broker over another.
However, one of the most important things to consider is cost.
Your broker and fund fees can have a massive impact on your investment returns.
People often get mislead into thinking the fees they are paying aren’t expensive at all, but here’s what Charles Schwab, the founder and Chairman of Charles Schwab Corporation (one of the first and biggest discount brokerages) has to say during an interview with Tony Robbins in Money Master the Game:
“For every 1% over the lifetime of investing, it’s 20% of your money you’re giving up. Give up 2%, that’s 40%. Give up 3%, that’s 60%.”
Charles Schwab
The bottom line is, there are all kinds of broker and fund fees that can damage your returns, but the main ones you have to watch out for are these:
- Platform Fees/Account Fees
- Commissions
- Exit Charges
- Ongoing Fund Fees
- Transaction Costs
- Initial Charges
- Bid-offer Spreads
- Stamp Duty
Platform Fees/Account Fees
A lot of brokers charge you an account fee, sometimes called platform fee.
Account fees can be fixed or they can be a percentage of the value of your account.
Some brokers don’t have any account fees at all. Some brokers charge a fixed fee no matter your balance, and others charge a percentage fee.
Those with fixed fees tend to charge between £20 and £150 annually and percentage fee brokers usually charge between 0.12 and 0.45%.
Generally, you’re going to be better with a percentage fee for smaller account sizes and a fixed fee for larger ones.
Commissions
Commissions are what you have to pay when you buy or sell a fund or share.
In my experience, these can range from free to about £25, but are commonly around £10.
Exit Charges
Many brokers charge you when you want to withdraw your money. This is typically in the £0-150 range.
Most people are only going to need to pay this once at the end of their investment lifetime.
Ongoing Fund Fees
Most funds have annual fees taken as a percentage of your balance. Look through any fund’s literature and you will find the ongoing charges figure (OCF) or total expense ratio (TER). Either of which refer to ongoing fund fees that you need to pay.
These are perhaps the most important fees of them all because they are continuous. Many of the other fees are one-off outlays, but ongoing fund fees stick with your througout your investment lifetime.
The Financial Conduct Authority (FCA) say average actively managed funds i.e. mutual funds and investment trusts charge 0.9pc a year before admin and trading costs compared to 0.15pc for the average a passive fund i.e. a passive index tracking ETF.
It is worth noting that there are plenty of REITs like British Land that are bought like shares which don’t have ongoing fees.
Transaction Costs
Funds buy and sell shares on your behalf. Say you invest in Fund A for example. Your money is pooled together with all the other investors in the fund. The manager of Fund A uses your money to buy and sell shares in various companies.
Just like investors, fund managers need to pay commissions when they buy shares, and commissions cost money. Funds that do a lot of buying and selling spend more on commissions than those who don’t.
Research from consultancy firm Lang Cat shows that on average investors pay 20% more for underlying buying and selling. But plenty of firms charge more than this. Henderson UK Absolute Return had transaction costs of 0.79% for example.
The good new is, there are still firms out there that don’t have much portfolio turnover at all. There were even funds with 0% such as Lindsell Train UK Equity.
Initial Charges
Mutual funds charge initial fees when you make a purchase. The other types of investment don’t.
It’s not rare to find funds charging 5%. However, according to the Money Advice Service you can expect the typical initial charge to be around 2%.
Bid-offer Spread
The bid-offer spread is the difference between the buy price and the sell price. Why is there a difference you may ask?
As we’ve already established, buying and selling shares on a stock exchange costs money. Rather than take the hit themselves, most funds will charge somewhere between 0 and 2% to cover their costs.
Occasionally, some funds charge more.
That said the Financial Conduct Authority (FCA) suggest an average of 0.079%.
Stamp Duty
Shares are liable for 0.5% stamp duty. This is paid when you buy shares of companies, investment trusts and REITs.
You don’t pay when you buy mutual funds or ETFs.
Summary
With all those fees is it any wonder that investors aren’t sure what they are paying?
Here’s a summary of the key differences or put another way, what you don’t pay in each case:
- Mutual Funds —> Don’t pay commissions or stamp duty
- Investment Trusts —> Don’t pay initial charges
- ETFs —> Don’t pay initial charges or stamp duty
- Shares —> Don’t pay initial charges, ongoing charges or transaction costs
The table below summarizes which funds generally attract which fees.
![Fund Fees](https://i1.wp.com/britishexpatmoney.com/wp-content/uploads/2019/05/Screen-Shot-2019-05-06-at-16.05.55.png?fit=800%2C545&ssl=1)
Using averages of all the broker and fund fees, I’ve completed a simple comparison of what fees you can expect to pay over a year of investing in each of the above investments.
I’ve made the following assumptions:
Platform Fees / Account Fees
A percentage fee broker charging 0.25% equating to £25.
Commissions
Invest quarterly and buy two funds, one for stocks and one for bonds. Commissions are £10 so that’s £80 in total.
You buy and hold your funds so there are no sell commissions.
Exit Charges
I’ve ignored exit charges as you’d only pay this once, rather than annually.
Ongoing Charges
0.9% for investment trusts and mutual funds and 0.15% for a passive ETF.
So that’s £0 for shares, £15 for ETFs and £90 for the others.
Transaction Costs
0.10% for passive index funds and 0.20% for investment trusts and mutual funds.
So £0 for shares, £10 for ETFs and £20 for the others.
Initial Charges
2% for mutual funds only.
So £200 for mutual funds and no charge for the others.
Bid-offer Spread
All charged equally at 0.079%.
So that’s £7.90 across the board!
Stamp Duty
ETFs, investment trusts and REITs pay 0.5%. Mutual funds pay nothing.
So £0 for mutual funds and £50 for the others.
Fund Fees Comparison
Using the above assumptions and assuming you achieved a 5% investment return, here is a comparison of what you might pay over one year for a £10,000 investment in two funds, drip fed quarterly.
![Fund Fees](https://i2.wp.com/britishexpatmoney.com/wp-content/uploads/2019/05/Screen-Shot-2019-05-06-at-16.49.43.png?fit=707%2C1024&ssl=1)
The table above gives an indication of what broker and fund fees you might pay on average on a £10K investment over one year.
Buying REITs that don’t have ongoing charges or ETFs are likely to be the cheapest options. Similarly, mutual funds are likely to be most expensive.
In fact, some mutual funds and investment trusts even have performance charges on top of their other charges. Charging 2% of any outperformance they achieve is more common than you might think.
However, that’s not to say there won’t be any exceptions.
Without doubt, there are expensive ETFs that are actively managed, and cheap mutual funds and investment trusts if you look hard enough. In general though, you’ll more than likely pay more for investment trusts and mutual funds than you will for individual shares and ETFs.
At first glance the difference between making £147.10 through investing in mutual funds and £327.10 through investing in ETFs on £10K doesn’t seem like that much of a big deal.
But it is the returns after fees that matter. The difference between 1.47% and 3.27% over time might be bigger than a lot of people imagine.
Considering that a typical pension time period might be 25 years, there’s a lot of time for compound interest to work its magic.
If you left £10K compounding at 1.47% for 25 years, you’d have £14,403. On the other hand, if it was compounding at 3.27% you’d have £22,354.
Why Pay Higher Fees?
If you are asking why people pay the high fund fees for mutual funds and investment trusts, I think it comes down to two reasons.
- They don’t know what they are paying.
- They think their fund is going to beat the market and provide them with better returns.
So it’s worth having a look at these two in more detail.
They don’t know what they are paying
Anybody who reads this article could sympathize with this, but as far as I am concerned the numbers in the table just go to show how important it is to know what you pay because fees eat into your returns.
They think their fund is going to beat the market
Without a doubt there are fund managers out there who beat the market. The question is, can they continue to do so? The overwhelming evidence indicates that further out-performance is unlikely.
It is easy to find fund managers that have performed well in the past, but past performance is no indication of the future. Even for fund managers that have out-performed in the past, the likelihood is that a period of under performance is just around the corner. (You can read more about this here)
Why pay for under performance when you don’t have to?
These days it is easy to put together a well diversified investment portfolio using cheap index tracking ETFs. By doing this you can be assured of market returns and historically the market has always proved to be generous.
It also worth being aware that there are brokers out there that don’t even charge platform fees or commissions on some of their products.
Keeping fees in the funds you invest in low through ETFs and minimizing the fees you pay your broker means you keep more of your money for yourself.
The bottom line is all fees matter so you need to do your homework before you invest.