Don't be shy, ask ii...is performance more important than fund charges?

30th December 2021 10:20

No question is a stupid one, so whether you want to find out what you need to do to start investing or how the stock market works, don’t be shy, ask ii. Email yours to: ask@ii.co.uk

Derek asks: I understand the advice to avoid funds where the charges are high, but since the charges are deducted from the fund price, surely the performance (after charges) tells you all you need to know?

Kyle Caldwell (pictured above), Collectives Editor, interactive investor, says: there's nothing wrong with paying a premium for a fund, providing the outcome is satisfactory – your fund's performance beats that of rival funds with cheaper charges, for example. After all, it is not desirable to buy a cheaper-than-average active fund that is consistently a substandard performer.

When it comes to fund charges, here's the state of play: actively managed funds and investment trusts tend to have annual ongoing charge figures (OCF) in the range of 0.7% to 1%, while passive funds – index funds or exchange-traded funds (ETF) – typically cost less than 0.25%. If the passive product is tracking the US or UK market, fees tend to be less than 0.1%. Some active funds and passive funds will charge more or less than these figures and are therefore cheap or expensive relative to their competitors.

However, the trouble is that when you buy an actively managed fund or investment trust, outperformance cannot be guaranteed in advance. Investors are buying in the hope the fund gets the better of a comparable stock market index and performs well versus its peers.

One thing investors can control is costs. And when it comes to costs, those higher charging funds that fail to produce premium performance can leave investors notably worse off.

For example, let’s say over 25 years an actively managed fund and a passively managed index fund give the exact same returns – an average of 5% every year. The active fund has a yearly charge of 0.75% versus 0.25% for the passive fund. A lump sum of £10,000 is invested.

If there’s no fund charge at all, the £10,000 would grow to £33,863. The passive fund will give the investor £31,904, with £1,959 taken as the fund fee. The active fund will be worth £28,307, with £5,556 absorbed in the higher fund charge. The difference between the two is £3,597.

If the example above was a higher lump sum of, say, £50,000 then the difference would be even greater.

In my view, percentage fees lull investors into a false sense of security. They appear small, but over the long run can significantly add up in pounds and pence.

These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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