Why it’s essential to keep an eye on your costs when investing
Investing involves making assumptions about the future. It’s inevitable. We are not talking here about trying to time the market in the short term. We’re talking about the long-term decisions you make about how much to invest and what assets to invest in. These choices contain implicit (and sometimes explicit) assumptions about the likely direction of inflation and interest rates, your own life expectancy, politics, and the range of returns you might expect from a given mix of active ingredients. All of these factors are unfortunately beyond your control.
However, a key aspect of investing is largely in your control, and it can make a huge difference to your returns. This is your investment cost. To take a simple example, if you invest £ 200 per month over 25 years with an annual return of 6%, with average costs of 0.5% per year, you will end up with a pot of just over 126,000. £. If you do the same at a cost of 1.5%, you’ll have just over £ 109,000. That’s a £ 17,000 difference that’s way better in your pocket than in the financial industry. So what should you watch?
Three ways to maximize value
For most investors, there are three key areas to consider to ensure that you are getting your money’s worth. First, there is the cost of your investments themselves. The funds are accompanied by management fees and operating costs. The ongoing charges figure (OCF) – see below – gives you an idea of what they are. But for most investors, the main distinction is in the type of fund. Passive funds – which only follow an underlying index – will almost always be significantly cheaper than active funds (which try to beat an index, but most of the time don’t). Active funds may be worth the cost, but unless you have a specific reason for choosing one, then passive funds should be your default.
Second, there are the costs involved in owning and managing your portfolio through an investment platform. There is no better one-stop option (see here for Cris Sholto Heaton’s overview of what to consider when investing overseas, for example), but you should look at the cost of l tax envelope (i.e. what the platform charges you for your Individual Savings Account or your Individual Personal Pension) and the costs of buying and selling the funds you want to hold. As a rule of thumb, fixed fees are usually best for those with large wallets, while percentage fees work best when your wallet is still relatively small.
Finally, there are tips. Most people can manage a simple long-term passive portfolio without help. But if you don’t want to do that, the range of inexpensive services that will do it for you is growing rapidly. Vanguard’s recently launched financial planning product will allow you to build a core portfolio of tracking funds at an all-in cost of 0.79% per annum. If your needs are straightforward, this is a useful benchmark to use if you are comparing costs elsewhere.
I’d like to know what the OCF was, but I’m too embarrassed to ask
The ongoing charges figure (OCF) indicates the annual operating cost of a given fund, expressed as a percentage; or, as the Association of Investment Companies puts it: “This is the percentage reduction in annual returns to shareholders due to recurring operating expenses assuming the markets remain static and the portfolio is not traded.” It replaced the Total Expense Ratio (TER), although you still find the latter term used, and there is very little difference between them.
The OCF consists of the fund manager’s fees for managing the portfolio – the annual management fee (AMC) – plus other fees, such as administration, marketing and regulation. Although OCF is considered (for now) the best measure of costs, it is not exhaustive. In part, that’s because it’s historic – there are certain costs that can only be known for sure once they have been incurred.
So, for example, the OCF does not contain any trading fees – such as brokerage commissions for buying and selling stocks, or for taking into account “spreads” between buy and sell prices. sale of investments, or for stamp charges. Therefore, a fund with a “high turnover” – that is, a fund that does a lot of buying and selling – might end up being more expensive in practice than a fund that has a low turnover and has an OCF. higher. The OCF also does not contain the impact of performance fees, although this should be easy to locate in the fund documentation (and in most cases you should not buy funds with performance fees of. anyway).
In short, the OCF is not a complete guide to fees, but for an active fund, if you want more details, you will have to dig to find it. For a passive fund (or tracker), the other key cost variable to look at is the “tracking difference”. This shows the difference between the performance of the tracker and that of the index it is designed to track, and thus gives an idea of the real impact of total costs on the performance of the fund.