My finances

What difference do charges make?

More than you think.

Whilst most funds (your work based pension scheme, stocks and shares isa or junior ISA) have annual management charges (amc), small differences in the amc can have a significant impact on the value of your investment.

Before we consider which funds have higher charges and whether these are justified, let’s look at the difference higher charges can make.

Consider someone who invests £3,000 per year into a stocks and shares ISA for 20 years:

  • Total contributions are £60,000
  • The accumulated value of investment assuming 6% pa growth before charges and charges of 1% pa = £102,000.
  • Fund value assuming 6% pa growth before charges and charges of 0.5% pa = £108,000
  • The impact of that extra 0.5% pa charge is therefore £6,000 or 5% of your investment.

Impact of higher charges over varying terms

The graph below shows the impact over different terms with different excess charges. As expected, the longer the term, and the higher the excess charges, the greater the impact on your investment.

Investment Charges Chart

Is the annual management charge the only charge I need to worry about?

This is where it can get complicated. If you invest in a fund (ie a basket of shares run by a fund manager such as an insurance company or investment management company), then you will pay an annual management charge. This will often be made clear. But two other charges need to be taken into account:

Initial charges
  • Some funds charge you just to start the fund. This might be 5% of your initial investment or if you are investing monthly, 5% of each contribution.
Trading costs (ie when the fund buys or sells shares)
  • If your fund buys and sells regularly, the charges can increase considerably. An active traded fund could easily add 0.5% pa to your overall charges.
  • Whilst it may add to the overall performance if the trades result in better assets with increased returns, an actively traded, actively managed fund will need consistently to make good choices just to overcome the extra fees.

Do active managers justify the extra charges?

Once charges reach a certain level, it becomes very difficult for an active manager to do better than the equivalent return on the index. Past performance tables show that not many active fund managers are able regularly to justify the extra fees incurred. Whilst some active managers do achieve this, trying to identify them in advance is very difficult, as many leading managers go on to underperform following a good period of performance.

Therefore, whilst we are not against active management, many investors might be better off with an index tracking approach (sometimes referred to as passive approach), where the annual returns broadly track the index returns of that investment class.