"There is no such thing as a free lunch"
We are used to paying fees for just about everything, and where it is not obvious there are any fees (like day-to-day banking) most of us realise the service cannot be cost-free, and expect to pay for the benefit somewhere.
Investing is no different. That said, there is lots of confusion and misinformation about fees, largely stemming from a lack of willingness by the investment management industry to be transparent.
What fees would an investor expect to pay?
For most people the fees come in approximately five or less flavours:
- A custody fee for the people responsible for holding and investing the money – platforms such as Hargreaves Lansdown, Charles Stanley Direct charge this
- A brokerage fee for buying and selling assets – usually where individual stocks and shares are bought, or in the case of some fixed-fee platforms this is charged with funds as well
- A trustee fee the people managing the legal structure of the investment – only usually relevant in the case of SIPPs – James Hay and Sippcentre are two examples of SIPP trustees
- A fund management fee – this is described as OCF (ongoing charges figure), TER (total expense ratio), TAC (total annual charge), or various other three letter acronyms, and is the cause of the most controversy within the financial services profession. These are not payable if you are buying individual stocks and shares. The Funds FAQ article provides further detail on these terms.
- An ongoing advice fee (if you engage a financial adviser)
In some cases, these fees are bundled. An obvious example would be a workplace pension, where a single provider will typically act as custodian, trustee and fund manager, and the costs will be bundled together.
Most private investors who do not engage an adviser, will use some sort of custodian/broker (most direct to consumer platforms are effectively both), possibly bundled with a trustee if investing in a pension, but will pay separate fund management fees.
The likes of Nutmeg quote their management fees, but are actually bundling ongoing advice fees and custodian/brokerage, underlying fund management costs to pay on top.
It is really important to make sure you are comparing apples with apples when it comes to investment costs. Common pitfalls include:
- Misunderstanding how the fees are broken down, and (for example), comparing a portfolio where the is ongoing advice provided to a self-managed portfolio. There are different services being paid for and the comparison is not necessarily valid.
- Ensure you have captured all the fees when comparing – I have seen questions around workplace pensions (say, 0.75% PA) vs. Hargreaves Lansdown (0.45% PA) where people haven't appreciated there are additional costs to investing with HL (namely, fund management costs)
Why, and how much, do fees matter?
We can see why fees matter by looking at the following table from Vanguard, estimating the amount of investment retained by the investor over time, depending on fees charged:
What we learn from this is:
- Big differences in fees make a big impact over long terms
- Big differences in fees make a smaller impact over short terms
- Small differences in fees make a small impact full stop
So far, so obvious. We do get a lot of questions sweating the difference in price between different platforms, so let's just take a moment to compare a scenario:
- Assume all investors have £10,000 and the "before-charges" return is inflation + 5% for all.
- Investor 1 buys Vanguard LS100 (0.22% PA) on Charles Stanley Direct (0.25% PA)
- Investor 2 buys Vanguard LS100 (0.22% PA) on Hargreaves Lansdown (0.45% PA)
- Investor 3 buys Fundsmith Equity (1.08% PA) on Hargreaves Lansdown (0.45% PA)
- Investor 4 buys a bespoke Discretionary Fund Manager solution (which we will assume costs 3% PA)
Results (after charges and inflation)
- Investor 1 has £15,570 after 10 years, and £24,260 after 20 years
- Investor 2 has £15,280 after 10 years, and £23,340 after 20 years
- Investor 3 has £14,070 after 10 years, and £19,780 after 20 years
- Investor 4 has £12,190 after 10 years, and £14,860 after 20 years
Obviously, with bigger investments and longer terms, the difference in after-costs returns increases.
Now, Vanguard and the others invest money in fundamentally different ways. (Most) Vanguard funds are passive index trackers, whereas the others are active managers who claim to have the skill to outperform investment markets, thus in theory commanding (and justifying) those additional fees.
One thing to note is that the identical investments were purchased by investor 1 and 2, yet their outcomes are slightly different, and these differences become more apparent over time.
Where can I find out what I am/would be paying?
If you already hold investments, ask your provider.
Brokers and platforms
If you are considering investing, Monevator have a comparison table of platforms. Most fund costs are equivalent between brokers, so as a DIY investor the key decision is finding a low-cost broker that meets your needs.
You can find detailed fund costs via your platform's website, third-party sources such as Trustnet, or fund provider websites. Be wary though, there are many different fund "unit types". What is available will vary depending on which platform you use.
Fees aren’t everything!
"Costs are what you pay, value is what you get"
Whilst fees are undoubtedly important, and getting them down will generally improve returns, there are myriad reasons why somebody may willingly pay additional fees. It doesn't automatically make people blithering idiots who are having the wool pulled over their eyes by big finance.
Some people are ardent believers in active management and are happy to pay more for the chance of outperformance. Others require ethically positioned investments to be able to sleep at night, and these tend to be costly. Others have complex tax affairs that don't fit a standard ISA & pension structure. Others just like paying more for better service. In the words of a colleague – "I know [insert platform here] are more expensive than the other d2c platforms, but my pension is still with them because they make managing my pension easier than the cheaper, clunkier efforts".
My day job involves charging professional fees to undertake financial planning with customers. I truly believe that the vast majority of them are better off after dealing with me than before, regardless of my fees. The days of financial advisers flogging an investment and charging a fee for doing nothing more are (hopefully!) long gone.