Costs Unwrapped

You've got a choice: wake up, or give much of your future savings away.

Disclaimer

This site was first written 10 years ago. When we looked at this subject today we found two things:

  • In its details everything has changed
  • In its essence, nothing has changed

So you'll forgive us if you let us get on with updating the easier bits of the site and come back to this later. You don't need the details; what you need is the picture. The following gives it to you. Only the details have changed.

The industry is there to help you - at a price

Buying shares directly incurs costs. Buying shares indirectly (through a fund or a structured financial product, for example) incurs other costs. The whole process is (deliberately?) opaque.

The regulator does its best to outlaw on your behalf the more egregious charges, particularly those that create incentives for biased advice. But it's always going to be one step behind. The list of costs in the next section includes some that are banned for many products at the time of writing. We make no apology for this. Forewarned is forearmed.

Excess costs can trash your savings through the mathematics of compounding. Be sure you understand the extra costs of any investment before you make it.

What are the costs?

If you are buying investments (e.g. shares) they may be in a pooled investment (e.g. a unit trust or an ETF) and/or they may be parcelled up in a 'wrapper' (e.g. an ISA). We use the generic term 'Pool' to describe the pooling vehicle (not all costs will apply to all types of pooled investment). The added costs may comprise any of the following:

  • Initial Pool charges
  • Exit Pool charges
  • IFA commissions
  • Buy/sell spread on the price of the Pool
  • Brokerage fees on selling the Pool
  • Stamp duty & brokerage fees on buying the Pool
  • Dealing costs on purchases/sales of shares within the Pool. Portfolio Turnover
  • Even higher dealing costs within a wrapper (you will find that some brokers charge more for trading within an ISA than they do for trading within a dealing account)
  • Stamp duty (0.5%) on buying shares within the Pool
  • Buy/sell spread on the price of shares within the Pool
  • Annual Pool investment management charges
  • Other administrative charges incurred by the Pool (typically 0.2% - 0.5%)
  • Annual wrapper management charges
  • Dividend reinvestment fees (when the Pool treats reinvested dividends as a new purchase and charges accordingly)
  • Performance fees, (particularly insidious)
  • 'Soft' commissions (when services such as technical analysis are supplied 'free' to a Trust by a brokerage in exchange for higher dealing commissions or guarantees on volume).

Also, don't forget 'Pools of Pools'. Most typically this is when a fund invests in other funds. It also occurs when you've delegated management of your wealth to an adviser who invests your money in its own funds; or in the funds of another manager with whom it has a 'special relationship'. In all cases you are incurring two levels of fees.

Phew! Anything else?

Yes, there's the little matter of renewal commissions (also called 'trail commissions').

If you are paying, say, a 1.5% a year fund management fee you might be comfortable with this high charge because you believe you are buying exceptional expertise.

But what if you discovered that your fund manager was rebating 0.5% to your financial adviser? So that only 1% per year is being devoted to the management of your money and 0.5% is paying for your seller's marketing costs. This 0.5% is the "renewal commission".

The industry argues that so long as it is honest about the amounts you are paying, why should you care who it is being paid to?

Our view is straightforward. Unless this arrangement is declared to you, this is a scam. The fact that it is legal doesn't make it any less so. And the convoluted arrangements and nomenclature to express something quite simple show that the industry knows it. If you meet it, you know what to do.

As a matter of historical fact the regulator banned trail commissions on products sold after 2012. We mention it above because:

  1. If you bought a product before then and are still holding it you may still be paying. The only way to stop it is to sell.
  2. The history of regulation is the history of plugging holes in a rusty bucket. Yesterday's scams may be banned, but today's scams haven't yet been uncovered. The water pressure remains - the need to reward intermediaries in the savings chain.

Initial commission

Many funds will charge an initial commission when you purchase direct, say 5%, though intermediary product providers will give you a discount. But the bad news is that they may only do so because they are receiving renewal commissions.

And it may not even be that simple. A recent (2019) survey by the Sunday Times found that some firms levy several layers of charges for one product, quoting: an initial advice fee; an initial product charge; an ongoing product charge; an equivalent annual management charge; and a fee reduction.

We repeat, we have no objection to these arrangements. We object to their concealment, which continues to distort the cost comparison between those offering a truly independent service and those who are taking a slice of your savings for not doing very much.