The way you are charged for buying investments changed in 2014 and brought with it the introduction of clean funds. What are clean funds and what does it mean if you invest?
Clean funds explained
Under the old system there were a range of charges that could be levied on someone investing in a fund, including:
- Annual management charge (AMC). This could be anything between 0.3% a year and 2%, depending on the type of fund you invested in. The annual management charge is something that you pay on your entire investment, not just on the money you pay in during one particular year.
SAVVY TIP: According to The Share Centre, which is an execution only broker, between 0.3% and 0.5% of the annual management charge could be used to pay a commission to a broker, an adviser or an investment platform (Investment platforms used to be called ‘fund supermarkets’ when they were first launched. They are now mostly referred to as platforms or investment platforms).
- Other charges, such as performance fees dealing and legal charges. Dealing and legal charges may not be spelled out.
SAVVY TIP: These charges were not affected by the changes to commission charges that were introduced in 2014.
Why is it changing?
Under what’s known as the Retail Distribution Review or RDR, investment funds cannot charge investors a commission that they pay to the adviser/broker or platform. Funds that don’t have these charges are called ‘clean funds’.
SAVVY TIP: The regulator, the FCA, banned investment funds from levying commission from 1st April 2014.
How do ‘unbundled’ charges work?
In theory the new system of charges should be cheaper, but you may end up paying a similar amount overall and through these ‘unbundled’ charges. However, the idea is that it’s clearer what you’re being charged for and by whom (although not all agree that the new system will be clearer).
Under the new system, you will pay two charges:
- A fee to the fund management company where you’ve invested your money: this will include a charge for managing your investments (i.e. deciding which shares to buy and sell) and other costs such as the cost of buying and selling shares.
- A platform fee: this is a fee that you pay the fund platform or execution only broker. This is levied by many platforms to replace the income lost because they can no longer receive a commission from the fund management company.
SAVVY TIP: You may also be charged other fees by the platform or execution only broker, such as dealing costs and administrative charges.
- Some funds that had high commission charges under the old system don’t have an equivalent ‘clean’ version.
Why do charges matter?
Charges are important because the higher the charges, the bigger the chunk of your return it will take. It’s not necessarily the case that investing in the cheapest fund is the best route to take, but it rarely makes sense to put your money in a fund that charges a lot.
Carolyn Gowen, who is a Certified Financial Planner with Bloomsbury Wealth Management, says: “Any changes which make it more transparent to the consumer what they are paying to invest are to be welcomed. The first principle of investing is – or should be – costs matter. Every pound not spent in costs is an extra pound of profit to the investor.”
CAROLYN’S TIP: The annual management charge (AMC) is only one element of the total costs an investor pays to own a fund. It is always worth looking at the ‘total expense ratio’ (TER) (otherwise known as the ‘ongoing charge’) figure as these can often mean that the overall cost of owning a fund is more than double the AMC.
Carolyn says that the current ‘price war’ on platform fees has been interesting to watch, and should ultimately benefit the end consumer, but includes a warning. “Beware the ‘Ryanair pricing methodology’. It’s important to consider the total costs being charged, not just the headline percentage charge based on the value of the assets held on the platform. The extras can soon add up.”
Useful links: There’s a useful website called Compare Fund Platforms, which has been compiled by a former independent financial adviser called Justin Modray. He runs a website called Candid Money which has lots of useful investment information.
Morningstar also has a fund comparison tool.
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