Cheap trackers: beware hidden fees

The cheaper a tracking fund is, the better. But watch out, not all costs are included in the published total expense ratio (TER) figure. Paul Amery explains.

Costs matter when it comes to investing. Small differences in annual fund expenses can lead to a big difference in the value of a fund a decade later. So it makes sense to buy cheap tracking funds whenever possible. But watch out the total expense ratio (TER) may not tell the whole story.

The TER, which all funds publish, covers the management fee and charges for services such as custody, audit and share registration. Actively managed funds often have higher TERs (1.5%-2% a year) than index-tracking funds (where it can be as low as 0.1%). But certain costs aren't included in the TER.

Money entering a fund has to be deployed. At that point the fund manager incurs dealing commissions and also the gap between buying and selling prices for the underlying securities (the bid-offer spread). Fund investors may also suffer taxes such as stamp duty on UK-listed shares. These costs affect investors, yet fall outside the TER.

The good news is that if you're investing in an index-tracking fund, these charges (which vary with the level of transactions undertaken by the fund) are likely to be much smaller than for an active fund. However, this is not always the case so it's worth checking the historic turnover figures first.

There are also some important differences between standard index funds and exchange-traded funds (ETFs), which are listed on the stock exchange. Take the Vanguard FTSE UK Equity Index fund. On the Bestinvest platform, for example, this has a TER of 0.15% and an initial charge of 0.5%. Meanwhile, the Vanguard FTSE 100 ETF has a TER of 0.1% and no initial charge.

But before you pounce on it as the cheaper option, there's the bid-to-offer spread to consider, along with the fact that it often trades at a premium approaching 0.5% of its underlying net asset value. So although there's no explicit initial charge as there is for Vanguard's index fund, you could end up paying the equivalent amount in other ways.

So in this case the main advantage of buying the standard index fund is its broader exposure (to the FTSE All-Share). With the ETF, it's the fact you can trade it at any time of day.

Given these swings and roundabouts, the type of fund you choose will depend on how often you trade, how often you save and your long-term objectives. Ideally, the platform you use should offer you access to both types of fund.

Paul Amery edits www.indexuniverse.eu , the top source of news and analyses on Europe's ETF and index-fund market.

Recommended

Why the market is wrong about private equity
Investment trusts

Why the market is wrong about private equity

When it comes to listed private-equity trusts, investors are overly sceptical, with many funds trading at heavy discounts to their net asset values. B…
9 Aug 2022
Asia: long-term opportunities amid short-term noise
Advertisement Feature

Asia: long-term opportunities amid short-term noise

In a tough first half of the year for financial markets, Asia has struggled more than most. But that weakness may represent an opportunity for invest…
26 Jul 2022
Analysis: it’s been a terrible six months for investment trusts
Investment trusts

Analysis: it’s been a terrible six months for investment trusts

The first half of the year has not been kind to investment trusts because of their skew towards growth stocks and the global downturn, says Max King. …
25 Jul 2022
The ten investment trusts with the highest dividend yields
Investment trusts

The ten investment trusts with the highest dividend yields

Investment trusts are one of the best ways to participate in the stockmarket, and the way they are structured means they can maintain their dividends …
22 Jul 2022

Most Popular

Are UK house prices finally heading for a crash?
House prices

Are UK house prices finally heading for a crash?

The latest house price figures show a fall of 0.1% in July. With interest rates rising, inflation hitting double figures and a recession on the cards,…
5 Aug 2022
Brace yourself for the return of rationing
Economy

Brace yourself for the return of rationing

Russia is turning off the cheap energy. That is already leading to belt-tightening, says Matthew Lynn. Who will suffer most, and which sectors will th…
5 Aug 2022
Fear of missing out – what should investors do now?
Investment strategy

Fear of missing out – what should investors do now?

Markets have rallied from their mid-June lows. But if you missed out, as most investors did, what should you do now? Max King explains.
8 Aug 2022