Investing fundamentals #8 – Keep an eye on charges

In the latest in a series of blogs about the ten fundamentals of investing, I explain why investors need to keep an eye on charges.

When you invest in funds, you typically pay the fund manager a percentage of your investment to manage the fund. This annual management fund can range from very small (as low as 0.1%) to very large (2.2% or even higher!), depending on the fund and management style.

Because fund charges will drag down the performance of the fund, you should keep an eye on charges to make sure you are getting good value for money.

Funds which adopt a passive investment strategy tend to have the lowest charges, as less management involvement is required to replicate a market index or asset class returns. Funds with active management charge investors more.

You should also expect to see higher fund management charges for certain asset types, such as commercial property and emerging market equities. Funds investing in these types of investment tend to have higher charges than fixed income funds.

Funds which invest in other funds (fund of funds) tend to have higher management charges than funds which invest directly into stocks and other assets. This is because investors are paying for two layers of fund management with a fund of funds approach.

When investing in a fund, take time to understand where your annual management charge is going. Many retail investment funds include an element of charging for the fund manager, investment platform and adviser. If you are investing directly without the help of an adviser, don’t pay advisory charges.

Modern investment platforms use clean share classes which means you only pay the fund management charge. Any platform charges are then charged separately, which avoids the old smoke and mirrors technique of fund rebates and loyalty bonuses.

Another type of fund charge to watch out for is performance related fees. These are popular in the world of hedge fund management and have been introduced by some absolute return fund managers. They result in the fund manager being paid up to 20% of the investment return once they perform above an agreed benchmark level.

Read about all ten investing fundamentals by downloading our free guide:

The Investing Fundamentals Guide 2014