Go direct to an investment company to buy its fund and you’ll pay over the odds. Bizarrely, if you want a unit trust, investment fund or shares ISA, the cheapest way is via a specialist Discount Broker, where you get the same fund but with less charges, meaning it’ll grow more quickly (or shrink less!).
This is a full guide to cheap investing, and the best discount brokers, which can boost your returns by over 60%, including the 'buying funds' calculator to work out what you'll save.
What are investment funds?
If you want to invest, you can either buy shares in an individual company, or get a ‘collective investment’, using a ‘fund’. Here you pool your money with lots of other investors, and a fund manager picks the actual shares or bonds bought. Your returns then depend on the agglomerated average performance of those assets.
Most funds have a specific theme, around which all the contained investments are based. For example one or a mix of:
- Geography. e.g. European, Japanese, Emerging markets
- Industry. e.g. Green companies, Utility companies, Industrial businesses
- Type. e.g. Shares, Corporate bonds, Gilts!
- Company scale. From worldwide conglomerates to trying to spot fledgling companies that will turn into another Microsoft!
The combination gives you the risk factor. For example if its focus is 'fledgling biotech companies in emerging markets', all the elements involve a high degree of uncertainty, and therefore if it goes well you could be in for massive gains, and if it goes badly, massive losses.
Alternatively it could be a "FTSE 100 tracker" where it simply invests in the UK's 100 biggest companies, and thus is much more mainstream meaning while there can still be substantial ups and downs, the fluctuations are likely to be smaller.
The types of funds
The most common form of such funds are unit trusts, investment trusts and the extraordinary-named ‘open-ended investment companies' (OEICs). With all these, money simply buys you a set number of ‘units’ each of which has a price that rises or falls according to the value of the underlying investment, e.g. shares, bonds, commercial property, cash or more funds. The return you get from such an investment depends on two main factors.
This is the crucial factor, and it will usually dwarf anything else. Do you want to know what to invest in? Me too. There is no right answer; no one can predict the future, the aim is to match up a set of investments with how risky you want to be and where you think the markets are going.
Investing is always a gamble; there's no right pick, no sure thing. Having said that, over the long term (that's more than five years) investing tends to outperform simply leaving your money in a top savings account, but there are no guarantees.
The return or loss also depends on charges. Quite simply charges can mean you spend £10,000 on an investment but only get £9,500 worth of it. However well or badly your investment performs, this means you're taking a hit. And that's what this article is about, how to reduce that 'charges hit'. There's also a tax impact too, though this can be avoided to an extent within a shares ISA.... read How Shares ISAs Work?.
For the cheapest way to buy individual shares, read Share Buying guide
What will it cost to invest?
It's important to understand that the charges set up on investment funds are based around both the fund management companies making money themselves and for commission to pay Independent Financial Advisers (IFAs) who recommend and organise their clients' investments (see Is it worth getting advice? later). That means there are two types of charges.
The initial charge.
This is an upfront chomp which is taken off your investment at the very start. So for every £1,000 you hand over, a fund with a typical 5% ‘initial charge’ immediately reduces your investment to £950. This money is mostly demarked to pay commission to IFAs.
The annual management charge.
Every year, a smaller bite of up to 1.5 per cent of your money is taken. These annual management charges (AMCs) or ‘trail’ fees are shrouded in grey mist since you don't pay them direct; you just receive proportionately less investment. The revenue from this charge is usually split between advisors, brokers, the software provider that made the transaction work, and the fund manager.
For instance, invest £5,000 in a fund with an AMC of 1.5%, and each year you’ll pay £75 to keep it running.
Now are you ready for the shocking bit... while many of these charges are intended to legitimately reward IFAs who pass you onto fund managers... if you spotted a new fund in the Sunday papers and went direct to buy it from the fund manager....
"Buy direct without advice and fund managers pocket
the commission themselves, so you're no better off!"
It’s been mooted the Financial Conduct Authority (the FSA as was) will review this situation, which is difficult to see as anything other than an expensive, irrelevant charge for a huge amount of investors, but nothing concrete has changed yet.
Invest cheaper: Use a discount broker
If these charges are making your pockets sore, you can blast your way through a lot of them by heading straight for a special ‘discount broker’.
In a nutshell, discount brokers are specialist ‘execution only’ firms that simply sell you whatever fund you request. Like IFAs, they receive commission from the fund managers but as they simply execute the transaction and don’t give advice, their costs are much lower.
In turn, this means they can rebate most of what they're given back into your fund, and a few will also give you a cut of the ongoing, year-on-year annual management charge it receives too.
Therefore if you want to invest without advice this is a much, much cheaper way to do it.
Choosing a Discount Broker
In most cases you want the one that gives you the most bang for your buck, though if you're investing in a shares ISA, then the investment choice within a fund supermarket is also important (see the Q&A section). Comparing discount brokers depends on three specific attributes.
How much of its cut it rebates.
Of course it's better to go for a discount broker that'll give you all its initial commission back rather than just half of it.
How much it gets in the first place.
Don't assume all discount brokers receive the same amount of commission for a specific investement. Different discount brokers can negotiate different commission structures with the fund managers. This is why you need to be careful not to assume claims of ‘zero initial commission’ means it's cheapest; it may well be the case but it doesn’t mean the overall initial charge to you is zero!
Will it rebate the annual management charge?
Most discount brokers make their money from the annual charge, as they rebate all of the initial commission. Yet some of the larger brokers are prepared to give back some of this too, making your investment grow even more quickly.
The UK's Top Discount Brokers
To find these top picks, the UK's major discount brokers were compared for overall charges on a range of funds. Overall there was no one winner for everything, but the top three listed below came out generally on top. Best practice is always get specific quotes from all three.
Of all the brokers surveyed, Hargreaves Lansdown tends to win by a nose; they rebate the entire fee for over 2,300 of the funds it sells. You can buy funds from any provider on the market, meaning anything you want to buy should be available through it. Plus a portion of the annual charge is rebated for many of the funds available. Link: Hargreaves Lansdown*.
Smaller broker Chartwell's fees are also amongst the lowest, with commissions rebated for both the inital charge and a hefty whack for the annual charge, which means for investments over a longer period it can be the winner. Chartwell can source any fund in the UK, though less, around 1,300, are available through its online 'fund supermarket'. Link: Chartwell.
Best Invest covers 1,100 funds, and rebates 100% of the commission it earns on initial charges, making it one of the cheapest discount brokers, especially in the first year of investment. It also has the advantage of some very strong research facilities. Link: Best Invest.
Any new cheaper brokers will be included in the free weekly email
Discount Brokers included in the survey: Allenbridge, Barclays Stockbrokers, Best Invest, Cavendish Online, Chartwell, Chelsea FS, Commshare, Funds Direct, Hargreaves Lansdown, Moneyworld, Selftrade, TD Waterhouse, TQ Online and Willis Owen. If you find a top discount broker not included that beats the above, please e-mail firstname.lastname@example.org
The 'Buying Funds' Calculator
Once you've checked the cheapest discount brokers for the fund you are after, it will often be clear which one's cheapest. However, with the interactions of initial and annual charges, sometimes you may still not be sure which discount broker will charge you the least. Even if it's obvious which discount broker is your top pick, the use of percentage fees can obscure how much you're saving over going direct to the fund manager.
In either case, pop all the figures into the 'Buying Funds' calculator. Enter how much you want to invest, and the number of years over which you want to know the cost of the fund, and the calculator will reveal how much you'll save by buying with a broker.
Your Investing Questions Answered
- How does investing differ from saving?
- How do discount brokers actually work?
- Can I put funds in an ISA?
- Can I use discount brokers to buy Shares ISAs?
- Is it worth getting Independent Financial Advice?
- Where should I go to get information on what funds to buy?
- What's the best way to compare the cost of funds?
- Not had your question answered?
How does investing differ from saving?
A. This guide has explained the cheapest way to invest. This is different from just saving. Put simply, it’s all about the risk.
Saving. You put money away in complete safety, and get it all back plus interest (see the Starting saving guide).
Investing. You risk the chance that you’ll lose some money (or get lower returns) for the chance that your money will grow more quickly.
They also differ in the way your cash is protected should the credit crunch worsen and, though still very unlikely, UK financial institutions collapse. In savings, the first £85,000 of your money is fully protected, but nothing after that. See the full Are your Savings Safe? guide.
Yet with investments if the product provider of an investment goes bust (e.g. a discount broker), you'll only get the first £50,000 back. However don’t confuse this with your actual investment performing badly and losing money; that’s simply the risk you take.
How does investing actually work with a discount broker?
A. As they don’t generally give advice, to invest your cash most discount brokers let you loose in ‘fund supermarkets’ such as Cofunds or Fundsnetwork. These allow you to pick and choose investments from a wide range with ease; you can transfer between funds online, with small charges of only around 0.25% of the amount invested.
This is great for people who like to play around with their invested cash, change investment type or risk regularly.
A. Yes, each year every UK adult gets a £11,280 tax-free allowance for savings and investments, up to £5,640 of which can be saved in cash.
This tax-free wrapper, known as an ISA, boosts the return on anything in it, as the interest earned is protected from the taxman’s greedy mitts.
Yet sadly the tax benefits of investing inside an ISA have been eroded somewhat. Now there's no tax release on dividends paid on shares, the main advantage of putting money in a shares ISA is you don't pay capital gains tax on profits you make. If you are putting money in funds, and also want to save, it's worth carefully considering whether you'll gain more from using up the £5,640 Cash ISA element first.
For example you are allowed to make £10,600 profit in the year, from selling investments and any other one-off gains, before you need to pay Capital Gains Tax, so if this is very unlikely to happen, there's no real benefit from using a shares ISA, whereas there is a genuine gain in interest from a cash ISA.
Can I use discount brokers to buy funds for a Shares ISA?
A. Yes; going through a discount broker actually gives you much more choice of what you put in your tax-free ISA wrapper.
When bought direct from the fund manager, only its ‘unit trust’ investments are allowed inside this tax-free wrapper, yet discount brokers will generally allow you to buy funds for your ISA from the fund supermarkets.
This means you can pick ‘n’ mix the funds in your ISA, giving good potential to spread the risk, plus play around with what you’ve invested in without paying huge fees or waiting 2 or 3 days for the transfer to happen.
Is it worth getting Independent Financial Advice to pick my funds?
A. The first thing to understand is advisors don't know the future any more than anyone else. Yet if you're a novice with a serious amount to invest, they do have the advantage of understanding the various risks available, and being able to look at minimising the tax impact of your investing.
In general I believe most people who are prepared to do some research, will probably gain more from the lower charges of going through a discount broker than from the advice of an IFA.
However there is a good hybrid scenario. If you are investing a large amount of money, for example £200,000 from a house sale, the commission you would pay after getting advice would be huge; a 5% initial charge would cost you £10,000. Yet if instead you ask to pay the IFA a fee for their time, even at £200 an hour, the cost of the IFA advice would be much lower, and then the IFA should be able to arrange it on a 'commission rebated' basis, effectively working like a discount broker.
For more information see the Where to get financial advice guide.
Where should I go to get information on what funds to buy?
A. High end broadsheet newspapers like the Sunday Times and Financial Times run detailed articles about what to invest in on a regular basis. Yet of course for sheer breadth of information the internet is a winner.
The discount brokers themselves offer free, easy-to-use research facilities to help you choose your funds. Hargreaves Lansdown*, Torquil Clark, BestInvest are all good places to start. There's also Trustnet – an online research tool – an exhaustive research tool that lets you compare performance over the past few years against other types of funds, plus websites like ADVFN and iii.co.uk have large forums discussing shares and funds.
There's nothing stopping you using these resources for research and then picking a different broker to buy from.
Have you found a good source for researching funds?
Discuss your favourite ways to find investments.
Whats the best way to compare the cost of funds?
A. The Fund Buying Calculator should be your first stop; it allows you to compare the total cost of owning and investing for up to ten years, taking into account both initial and annual charges.
Yet buy directly from a fund manager and there are often a few extra sneaky fees, such as legal and marketing costs. All fund literature must include the total expense ratio (TER), calculated by dividing the total assets in the fund, by all the charges you have to pay, making it more accurate than just looking at the annual and inital charges.
The lower the TER, the better – less than 1 per cent is good - since it means much more of your returns go back to you. Most discount brokers will list the TERs in their list of funds.
Not had your question answered?
A. I don't cover "what to invest in" so if you've questions about specific investment, sorry I can't help. Yet if there's a general question about discount brokers or buying funds that hasn't been covered in this guide, then please ask it here and we will try and include it. If you want to give general feedback about your experience of discount brokers, then instead please discuss it here.