Does investing cost more than you thought?
Relevant to: Unit trusts and the risk factor; trading and investing in exchange traded funds; today’s stockmarket; investing and the internet
There are many references throughout SPI to the costs of various investments. Knowing what these are, and being able to reasonably compare similar investments, is critical to making the right decision. In the past the industry’s best cost measure has been the TER or Total Expense Ratio.
But the introduction and growing popularity of Exchange Traded Funds (ETFs), whose costs are much more transparent, has led some to start digging deeper to discover what the real costs of the traditional alternatives would look like if they were disclosed on the same basis. It transpires that the TER is far from total: the headline management fee is just the tip of the iceberg.
Hidden charges are present in almost all investment products, ranging from funds through to the new Defined Contribution Workplace (DCW) pensions, those that companies are currently setting up for their employees following the government’s progressive introduction of compulsory private pensions. Most employees enrolled will rely exclusively on their employers to provide a value for money service, but may only see a document to sign as acknowledgement of enrolment. They have no understanding of what they are buying or if it represents value.
And legislation that is intended to make investing and its costs clear and understandable to consumers may actually be working against them. Take RDR, the Retail Distribution Review, designed to stop “advisors” taking commissions from product providers, and setting new levels of academic qualification for anyone wanting to be called an advisor. RDR has arguably split the market into those that can and will pay, and those that can’t or won’t. And while investors with the knowledge and confidence to make their own investments should be able to do so with greater safety and effectiveness, the majority are likely to be at the mercy of indecipherable charging structures and unscrupulous, or at best opportunist, providers. Gareth Shaw, editor of Which? Money thinks that rather than save investors from mis-selling, it may drive them to mis-buying.
You might think it would be a simple matter to compare the costs of two trading platforms offering ISA/SIPP accounts, and that at least one of the many “comparison” websites would be able to provide a clear side-by-side guide for two providers. But they don’t, or possibly can’t. Such platforms are often effectively just acting as introducers, and any comparison of their TER would be almost meaningless, since most of the real costs lie in the funds they invest in, or the brokers they use to make their investments. It is complex, but the which.co.uk website makes the best stab at it, though it does require you to read a list of 30 sub notes for clarification.
Shadow Pensions minister Gregg McClymont has suggested that the industry is not moving forward at all, but is rather walking slowly backwards. With one seventh of all public spending going to the retired, the last thing the UK can afford to happen is for private pension investments – intended to keep pensioners out of state care – to pay unnecessarily high charges, estimated by investment advisors SCM Private – run by investment managers Alan and Gina Miller – at as much as £16bn per year.
In an attempt to get this exposed, and to provide a transparent alternative to encourage the investment industry to change its ways, SCM Private have driven the True and Fair Campaign. Putting their clients’ money where they mouth is, they only invest in ETFs, where the standards of transparency set a benchmark for the rest of the industry.
A new pricing formula
They have proposed a code based on a single clear total fee, in pounds and pence, in a single understandable, common, fee format that is disclosed prior to purchase; and 100 per cent transparency of any investments made, with a list of assets published at least quarterly. Industry objections to this predictably fall into three main areas:
• that if investors knew the real costs, they would not invest,
• that it’s too difficult to calculate a single price, and
• that change should be voluntary rather than through legislation.
To put this in perspective, the Treasury itself shows that pensions on average cost 3.2 per cent per year, way over the headline “TER” band of 1-1.5 per cent. Other concerns include increased fees for “active management” of a fund, when only a small percentage is actually managed, the rest being passive through index tracking. Having costs cloaked like this would not be tolerated in any other industry.
If there is to be an – inevitably prolonged – effort to change industry practice, the other side of a pincer movement strategy is to make sure that those taking steps to ensure that they won’t be reliant on a state system are not penalised through their own lack of awareness.
Research shows that 62 per cent of British investors would be more confident, and would invest more, if there was full transparency. 74 per cent want a “one number” price system – through legislation if necessary – and 81 per cent would like a fees breakdown in an understandable format.
The True and Fair Campaign proposal for a schedule of fees – see figure 1 – also has a calculator that enables investors to check any of 7,000 funds listed to see what the real costs are. You can find this very useful tool at TrueAndFairCalculator.com.
British investors have been conned for far too long. Products such as ETFs, and the US investment industry as a whole, show that transparency on cost disclosure and the actual assets is not an impossible pipe dream. But it will take investors asking questions, and perhaps changing their investment strategies, to make platform and product providers and fund managers realise that they mean business.
Those already well into retirement have little hope of redress unless they can claim lack of true cost disclosure constituted mis-selling. But those thinking about it or just into it can probably benefit from rattling some cages. And of course those that have not started planning or saving yet will be the biggest winners – as long as they know enough to ask the right questions of the institutions to which they entrust their retirement funds.
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