How to Save Costs When Investing

In the world of investing, your investment returns after fees is king. Shaving 0.5% off your annual costs is equivilent to adding 0.5% onto your stockmarket returns, so every investor should be taking all practical steps to keep their investment costs as low as possible.

Types of Investing Costs

Investors pay stamp duty (UK only), brokerage fees, bid/ask spread costs, annual management charges, administration charges, and sometimes performance fees on some funds. We will take a look at each of these cost types and how

Stamp Duty

Stamp duty is paid at 0.5% on the value of any purchases of shares. Exchange traded funds do not count, and are therefore stamp duty free – however the funds themselves may have to pay stamp duty on their underlying investments. Stamp duty becomes an issue in high frequency trading whereby you are holding onto each investment for only a brief period of time. In such cases, stamp duty costs will really begin to roll up and take large bites from your returns. For low frequency investors, stamp duty is unavoidable and negligible and therefore isn’t worth worrying about.

Brokerage Fees

Brokerage fees encompass trading commissions and fees for advice from full service brokers also. It goes without saying that the simple tip for cutting brokerage costs is to choose a discount broker over a full-service brokerage. Discount brokers charge only a fraction of the full-service fees, which will have a substantial impact on investment of less than £10,000.

Bid/Ask Spread Costs

When buying shares in the market, the buy price is slightly higher than the sell price. This leaves a small margin for ‘market makers’ which are like the second hand car dealers of the stock exchange. Where trading volumes are high such as for the FTSE 100 shares, or the S&P 500 shares, a market maker has plenty of competition and requires only a small margin. However where only a handful of shares (<100k) are traded per day, market making becomes a risky business, as any shares on their books that remain unsold could rise or fall in fall, potentially destroying their ideal margins. As a consequence, the differences between the buy and sell prices for uncommon listed securities will be larger (up to 5%), which causes an instant loss equal to that amount once you purchase the shares – as they are valued in your portfolio at their sell price, not the price you bought them at.

To reduce Bid/Ask costs, invest in highly traded shares and/or funds that invest in highly traded securities. Even if a fund is very large – it will still incur large bid-ask costs in its own purchases if it buys the shares of small companies.

Annual Management Charges

These are levied by actively and passively managed mutual funds, including OEICs, Unit Trusts, Investment Trusts and Exchange Traded Funds. It is widely regarded that unit trusts and OEICs have the highest annual management fees, whilst older investment trusts and passively managed ETFs have the lowest management funds. Active managers aim to outperform the index and ‘earn’ the premium they charge you, but statistics have shown that very very few fund managers have proven they can consistently beat the market, therefore I prefer to save 1% in management fees guaranteed and invest in a passive fund, rather than paying over the odds in the ‘hope’ of outperforming the market. Read more about the differences between passively managed versus actively managed funds.

Administration Charges

Admin fees are charged by your broker or stocks & shares ISA account which holds your shares. These vary from broker to broker, with some firms waiving the fee if you deposit and maintain a reasonable minimum balance. If you do your research on different accounts, you should be able to avoid admin fees entirely, even on ISAs. To start you off, my chosen account; TD Waterhouse Trading ISA, charges no ISA fees if you hold £5,100 as a balance then no periodic fees will be payable.

Beware also of  ‘inactivity fees’, which several brokerages use. Sometimes these are charged when fewer than 1 trade has been placed in a quarter, and sometimes these are only charges on accounts with low balances. Be sure to read the basic T&Cs on all types of fees to ensure you know where you stand in terms of periodic charges.

Performance Fees

Performance fees are creeping into the fee structure of many unit trusts and OEICs. Financial advisors are slowly shifting away from Unit Trusts in favour of lower cost funds in response to recent publicity given to the damage these fees can have on shareholder returns. In response, fund management companies have been launching funds with lower annual management charges – however these are subsidised by a performance charges in some cases. An example of a performance charge is “20% of any performance of the fund above the FTSE100 index”. Therefore if the fund gained 20% in a year when the FTSE100 rose by 15%, then 1/5th of the 5% outperformance would be taken as a performance fee. I’m not a fan of performance charges, as they encourage the fund manager to take extra risks (to produce extra gains) even if those risks carry disproportionately high risk of losses.

Performance fees can be avoided by sticking to simple, low cost funds that only use fixed annual charges.

Refer to our larger guide on How to Invest in Shares for more tips on investing.

In the world of investing, your investment returns after fees is king. Shaving 0.5% off your annual costs is equivilent to adding 0.5% onto your stockmarket returns, so every investor should be taking all practical steps to keep their investment costs as low as possible.

Types of Investing Costs

Investors pay stamp duty (UK only), brokerage fees, bid/ask spread costs, annual management charges, administration charges, and sometimes performance fees on some funds. We will take a look at each of these cost types and how

Stamp Duty

Stamp duty is paid at 0.5% on the value of any purchases of shares. Exchange traded funds do not count, and are therefore stamp duty free – however the funds themselves may have to pay stamp duty on their underlying investments. Stamp duty becomes an issue in high frequency trading whereby you are holding onto each investment for only a brief period of time. In such cases, stamp duty costs will really begin to roll up and take large bites from your returns. For low frequency investors, stamp duty is unavoidable and negligible and therefore isn’t worth worrying about.

Brokerage Fees

Brokerage fees encompass trading commissions and fees for advice from full service brokers also. It goes without saying that the simple tip for cutting brokerage costs is to choose a discount broker over a full-service brokerage. Discount brokers charge only a fraction of the full-service fees, which will have a substantial impact on investment of less than £10,000.

Bid/Ask Spread Costs

When buying shares in the market, the buy price is slightly higher than the sell price. This leaves a small margin for ‘market makers’ which are like the second hand car dealers of the stock exchange. Where trading volumes are high such as for the FTSE 100 shares, or the S&P 500 shares, a market maker has plenty of competition and requires only a small margin. However where only a handful of shares (<100k) are traded per day, market making becomes a risky business, as any shares on their books that remain unsold could rise or fall in fall, potentially destroying their ideal margins. As a consequence, the differences between the buy and sell prices for uncommon listed securities will be larger (up to 5%), which causes an instant loss equal to that amount once you purchase the shares – as they are valued in your portfolio at their sell price, not the price you bought them at.

To reduce Bid/Ask costs, invest in highly traded shares and/or funds that invest in highly traded securities. Even if a fund is very large – it will still incur large bid-ask costs in its own purchases if it buys the shares of small companies.

Annual Management Charges

These are levied by actively and passively managed mutual funds, including OEICs, Unit Trusts, Investment Trusts and Exchange Traded Funds. It is widely regarded that unit trusts and OEICs have the highest annual management fees, whilst older investment trusts and passively managed ETFs have the lowest management funds. Active managers aim to outperform the index and ‘earn’ the premium they charge you, but statistics have shown that very very few fund managers have proven they can consistently beat the market, therefore I prefer to save 1% in management fees guaranteed and invest in a passive fund, rather than paying over the odds in the ‘hope’ of outperforming the market. Read more about the differences between passively managed versus actively managed funds.

Administration Charges

Admin fees are charged by your broker or stocks & shares ISA account which holds your shares. These vary from broker to broker, with some firms waiving the fee if you deposit and maintain a reasonable minimum balance. If you do your research on different accounts, you should be able to avoid admin fees entirely, even on ISAs. To start you off, my chosen account; TD Waterhouse Trading ISA, charges no ISA fees if you hold £5,100 as a balance then no periodic fees will be payable.

Beware also of  ‘inactivity fees’, which several brokerages use. Sometimes these are charged when fewer than 1 trade has been placed in a quarter, and sometimes these are only charges on accounts with low balances. Be sure to read the basic T&Cs on all types of fees to ensure you know where you stand in terms of periodic charges.

Performance Fees

Performance fees are creeping into the fee structure of many unit trusts and OEICs. Financial advisors are slowly shifting away from Unit Trusts in favour of lower cost funds in response to recent publicity given to the damage these fees can have on shareholder returns. In response, fund management companies have been launching funds with lower annual management charges – however these are subsidised by a performance charges in some cases. An example of a performance charge is “20% of any performance of the fund above the FTSE100 index”. Therefore if the fund gained 20% in a year when the FTSE100 rose by 15%, then 1/5th of the 5% outperformance would be taken as a performance fee. I’m not a fan of performance charges, as they encourage the fund manager to take extra risks (to produce extra gains) even if those risks carry disproportionately high risk of losses.

Performance fees can be avoided by sticking to simple, low cost funds that only use fixed annual charges.

Refer to our larger guide on How to Invest in Shares for more tips on investing.

Simon OatesHow to Save Costs When Investing