This week, investment trust trade body the Association of Investment Companies (AIC) called on HM Treasury to scrap stamp duty for investment trust shares. Which got me thinking me about investment costs and how hard they are to work out.
There are basically three elements which make up the total investment costs you pay. Some are very transparent, others much less so. Here we look at what they are, and how to work out what you’re really paying.
This week, the AIC has called on HM Treasury to scrap stamp duty. Or more precisely stamp duty and stamp duty reserve tax. The difference between the two isn’t that important, but the point is when you buy shares in an investment trust, a real estate investment trust (REIT) or a venture capital trust (VCT), you are very likely going to have to pay 0.5% of the value of your investment in stamp duty – essentially a tax on buying shares, paid to the government.
The AIC argue this is unfair for two reasons. First, investment trusts themselves already pay stamp duty when they buy shares into their portfolios. This means you pay twice. Second, purchases of most open-ended funds have been exempt from stamp since 2014. That means the playing field isn’t level. Hopefully the government will take heed. In the meantime, this and other taxes are a fact of life for investors.
Tax is also an investment cost you can’t control directly. Stamp duty is automatically added to share purchases by your investment platform. Income tax on dividends and capital gains tax on rises in the value of your investments are also compulsory over certain minimums. Thankfully, you can minimise or reduce these taxes entirely by using an individual savings account (ISA) or self invested personal pension (SIPP).
Investment costs you can control
But there are other costs you can control. For example, the platform you choose will impact your investment costs. They charge fees for trading (buying and selling investments) and for holding your investments with them (custody).
Trading fees tend to be a fixed cost per trade. Each time you buy or sell shares, a trade can be anything between £8 and £12. That said newcomer Freetrade is now offering, as the name implies, free trading. Custody fees, often also called platform fees, tend to be a percentage the value of the investments you hold. Some cap these percentages, others don’t. There are exceptions – Interactive Investor charge a flat platform fee, but this makes holding small portfolios with them expensive.
The key to minimising these costs is understanding how you will use the platform in the future. That’s a tricky question to answer as it will depend how often you think you will trade, and how big the value of your investments are, or will be. There are tools out there which can help narrow the choice is you can make a sensible guess, for example, Compare the Platform.
Fund investment costs
The final and most confusing element to the investment costs triangle are the fees charged by the investments themselves. Investment trusts, funds and exchange traded funds all have fees associated with running them. These are all percentages of the value of the investment, and they are all taken out of the investment returns you get. So, unlike tax and platform fees, you’re not paying these out of your bank or trading account balances.
These fees range from tiny, say 0.06% for an exchange traded fund tracking the 100 biggest companies in the UK, to north of 3% or even 4% for a specialist investment trust. These fees are known as the OCF – the ongoing charges figure – and are calculated according to prescribed methodology by the regulator. You will almost certainly find the OCF on the investment’s factsheet or website. So far, so good, but here’s where it gets problematic.
First, some funds and investment trusts have performance fees. These are where the fund manager gets bonus for doing well. So it’s worth checking out the OCF both excluding and including performance fees as the differences can be eye-opening. Some performance fees can be substantial and have a significant impact on your returns.
The second point is that the OCF doesn’t actually include all the charges associated with running the fund. For example, when a fund manager buys and sells investments, dealing costs apply. These aren’t included in the OCF. Worse, they can be substantial too. If your fund manager has a high turnover because they buy and sell a lot, then the costs can really mount up. Worse still is that to find out what these costs are is pretty hard as they often don’t appear as a separate entry in a fund’s annual report.
Regulation comes to the rescue?
In an effort to sort some of this mess out the Europeans issued a new methodology, the results of which can be seen on the Key Information Document (not to be confused with a Key Investor Information Document). This makes a disclosure of trading and other costs, so is helpful in one sense.
However, the requirement to produce this document only applies to investment trusts and exchange traded funds – not to open-ended funds. So in effect you have two different numbers for two different structures of investment that are essentially working in the same way.
Also the calculation requires managers to disclose costs for things that can actually benefit the investment, for example the cost of borrowing money to invest must be included, but not any benefit arising from doing so.
So regulation hasn’t come to the rescue at all. In fact it’s made things even more confusing.
Keeping investment costs low
Given the obvious difficulty of adding these costs up, and the fact that an apples with apples comparison is often impossible, what can you do to make sure that costs aren’t eating into your returns any more than is necessary?
- Minimise tax – use a tax wrapper like an ISA or a SIPP to shelter your investments from tax.
- Choose a platform wisely – match the way you will use the platform to the fees they charge.
- Look beyond the OCF – this is a simple place to start, but doesn’t give the full picture.