Personal Finance - The lowdown on high charges
Save and invest - we all know we should be doing more of it, but how do we find the best deals?
Save and invest - we all know we should be doing more of it, but how do we find the best deals?
Everyone wants to spot a top-performing investment, but few of us think about the other half of the equation: how much of your money is taken to pay for commission and running charges.
Take the example of a typical actively managed PEP (or ISA) fund. It’s no use being seduced by an investment fund which has grown at, say, 8% a year when there’s an initial charge of 5% – so only 95% of every payment you make gets invested. (This is bad enough on lump-sum investments but worse if you only put #50 a month into a PEP/ISA). Plus, you are charged 1.5% a year for management costs on many PEPs, leaving you with a grand return of 1.5% – less than inflation. And what happens if fund performance starts to slip?
Fund managers stress the importance of looking at investment track records rather than just the charges. They have a point: a top-performing investment or pension will generate a lot more growth than you pay out in charges.
And even the firms which specialise in paring down costs agree that charges aren’t everything. Gordon Maw, marketing manager at Virgin Direct, says: ‘Buying a cheaper product is like being at the front of the grid for the start of a Grand Prix. It doesn’t guarantee you are going to win the performance race – but most people would like to give themselves the best possible start.’
The key to getting the best value from your financial planning is to understand what charges are made and whether you are getting a good deal – does past performance more than make up for the costs?
If you are deciding on buying some new investments or insurance, you should start off by wading through the bumf and calling the provider if necessary to get the charging structure clear in your mind – accountants should be better placed than most people to do this. Then you should also check where you can buy the same product with lower charges from a discount broking firm.
The cost differences can be staggering: a 30-year-old buying a Scottish Widows personal pension and paying in #100 a month would build up a fund worth a projected #132,000 at retirement. If he or she bought the pension through a discount broker which repays all the initial charges back into the customer’s pension fund, the pension would be worth an extra #10,000 by retirement. There are much bigger savings to be made if you invest more than this in your pension.
If all this effort is baffling, help is on the way. In this year’s Budget, the chancellor announced that the Financial Services Authority will publish lists of the total charges on all savings, pension and insurance products. These ‘league tables’ will make it much easier to wade through the mud in search of a decent value deal.
The FSA will start to consult interested parties this summer, and we should see the first tables later this year.
It’s another victory for customers in the battle against an industry obsessed with obfuscation and hidden charges.
Stock market funds (including PEPs and ISAs)
Most investors are pushed towards unit trusts (whether or not the fund is being held as a PEP). There are many reasons for this, the cynical one being that charges (including commission payments) on unit trusts are much higher than those paid on investment trusts. The charitable interpretation is that unit trusts are less volatile than investment trusts and so are more suitable for ‘novice’ investors.
Unit trusts have three sorts of charges:
– Initial charge (sometimes called the bid/offer spread). You pay this directly every time you pay into the fund.
It’s usually 4% to 6% of what you invest.
– There may be exit fees if you sell your investment within three years of buying it. You pay this directly, and it usually starts at 3% in year one, decreasing to 1% in year three.
– Annual management fees and other expenses. These costs are either hidden in the selling price of the units (known as the bid price), or the money is taken from the income your fund makes. Watch out for ‘extra’ charges on top of the quoted management fee.
Most investment trusts have initial charges and management charges, but are much cheaper. Initial charges range from 0% to 3.5% and annual charges from 0%to 1.5%.
A few unit trust managers have switched their funds to make them OEICS (open-ended investment companies). These have similar charges to unit trusts but the advantage of a single price for shares in the fund, whether you are buying or selling them. This stops managers hiding charges in the bid/offer spread (the difference between your buying price and the price you get when you sell).
How to cut costs: buy a PEP, ISA or simple unit trust from a discount broker (see box). You will get back at least 3% of the initial charge and sometimes the whole initial charge (up to 6%) will be rebated. You have to make the investment decision but all the listed firms have excellent literature. If the investment you want isn’t listed, ask the firm to quote for you. They can supply almost all funds if you ask.
Investment trusts are already cheap so go direct to the fund manager. Contact the Association of Investment Trust Companies to find out more about individual trusts and performance statistics.
The standard commission paid to an adviser or salesman who sells you a pension is about half of your first year’s premiums. When you add on the setup and management charges, you will see a lot of your payments wiped out. Many charges are obscured by jargon. This may include:
Bid/offer spread: as for unit trusts, this is the cost of buying into the fund. Generally about 5% of each payment.
Policy fee or plan fee: a charge for the privilege of paying in each month. May be 2% or a flat fee, say #2.
Allocation rate: this is a real nasty. You may see an offer giving ‘105%’ allocation. But this isn’t 105% of what you pay in. It’s done after the bid/offer spread (as above) is taken out.
So you lose 5%, leaving 95% of your money. Then an extra 2% is invested.
So in fact 97% of your cash is put into the pension. Less all the other charges, which include penalties for moving your investment between funds, for deciding to change your retirement date and even for increasing the amount you pay in each month.
How to cut costs: a few discount firms will sell you a pension with consistent past performance and most charges stripped out. You have to decide which pension to buy, but there is good literature to help you.
TQ Direct Choice offers pensions with no initial charge from big-name providers (Standard Life, Scottish Widows). You pay #50 plus VAT to set up the deal. Hargreaves Lansdown also has a range of pensions and has set up an exclusive deal with Friends Provident to offer a pension with no initial fee, no bid/offer spread on payments, and none of the hidden ‘extras’.
Another tactic is to buy a single premium pension, which is particularly attractive to self-employed accountants. The best of these pensions allow you to make lump-sum payments when it suits you. They pay much less commission than regular savings pensions and these payments are taken during the life of the policy – called ‘level loading’ – rather than being given upfront to the person who sold it to you. Again, you can even save on these charges by going through a discount broker.
The simplest life assurance policies are term policies, which pay out a lump sum if you die during the insured period. It’s cheap and the market is competitive. But salespeople get paid lots of commission.
The cheapest quote for a 40-year-old non-smoking woman wanting #200,000 worth of cover for ten years (this could be used to help bring up children if she dies) is #21 a month. The adviser would get #374 commission. The most expensive policy would pay #665 commission on a #36.80 premium.
How to cut costs: this is one area where you can claw most of that money back. Go to a direct provider (Virgin, Direct Line, Equitable Life) which does not pay commission, and compare their quotes with those drawn up by a discount broker. These firms usually pay about 65% of the commission back. Work out which method saves you more cash.
Endowments combine life assurance and investment. They are very expensive to set up, mainly because there’s lots of commission on offer. Many people are turning away from endowments except as a second-hand investment.
Most of the charges are made in the early years, and if you cash-in within seven years of taking out a policy you will almost certainly get back less than you have put in. How to cut costs: buying a policy second-hand as an investment means someone else has done the hard part and paid the ludicrous setup charges. You then pay the premiums until the policy matures and claim the payout.
COMMISSION: WHAT THEY DON’T WANT YOU TO KNOW
All financial salespeople are paid commission and most of them depend on it to make a living. But how much can they expect to get?
The standard scale for life insurers’ commission rates is called Lautro (after a defunct financial regulator). The figures quoted are the general (‘100%’) Lautro rates. You may see advertising aimed at salespeople which suggests payments of ‘130% Lautro’ or more, so add on the appropriate percentage.
Advisers are very cagey about these figures, so keep this handy and use it to your negotiating advantage.
All rates are for ‘indemnity’ commission – upfront commission paid right away. The quoted percentage is applied to the first year’s premiums. On a personal pension, the standard deal is half first-year premiums. Some advisers will get 60% more than this.
Endowments: on a 25-year mortgage endowment, 66.35% (as a percentage of your first year’s premiums).
Term assurance: 111.86% on a 25-year policy.
Personal pensions: 44.7% on a policy with 20 years to retirement; 49.57% with 25 years or more to retirement.
Income replacement insurance (also known as PHI – permanent health insurance): 95.88% on a policy lasting 12 or more years.
Association of Investment Trust Companies (AITC)
for more information: 0171 282 5580
Association of Policy Market Makers (APMM)
for a list of second-hand endowment sellers, call: 0171 739 3949
The latest Money Marketing PEPs survey shows the effect of charges on a range of PEP investments (will also apply to ISAs). It’s not exhaustive but this data is normally impossible to find. It costs #4.95 with a credit card from 0171 292 3730.
Discount PEP/ISA (and unit trust) brokers:
– Chelsea Financial Services 0171 351 6022
– Garrison 01482 861 455
– PEP Direct 0800 413 186
– Unitas 01724 849481
– Best investment 0171 321 0100
– Hargreaves Lansdown 0117 980 9926
– TQ Direct Choice 0800 413 186
Discount life assurance:
– Financial Discounts Direct (also do PEPs) 0500 498 477
– TQ Direct Choice 0800 413 186.