What Are Fund Fees?

Holly Black: Welcome to the Morningstar Investment Board. I'm Holly Black. Today, we're talking about fund fees. So, this is the charge you pay for investing in any fund or investment trust. And the reason this is so important is because the more you pay, the less you get back on your returns because it's going to eat into the growth that you're getting on your funds. So, think of the investment charges as a very hungry Pac-Man eating all your savings. You thought Pac-Man was one of the good guys; he's not.

So, the financial regulator did some research a couple of years back and they found that the average fund fee is 0.75%. So, that is about 75p on every £100 you invest basically that you can expect to hand over in charges to the fund manager. But the variety of fees is incredible, and you can get two funds that are seemingly pretty identical in what they're aiming to achieve; one might charge you 2% and one might charge you 0.5%. So, it's like going to the supermarket on your lunch break and there being two identical sandwiches. I mean, I don't know any sandwich has ever looked that unappealing. But one charges £5 and one costs £1. If they're the same, you should probably be picking the £1 sandwich and maybe get some crisps with the rest of the money.

So, it can be quite difficult to compare fees because they have a lot of different names. This is another way the industry tries to bamboozle us. So, we can have the AMC, the OCF, the TER and the TCO. In case you're wondering, that's annual management charge, ongoing charge figure, total expense ratio and total cost of ownership.

So, the annual management charge is like the basic fee you're paying for the just investing in the fund. These are the ones that include other bits and pieces like the cost of buying and selling the shares for the fund manager and the administration and the people they pay to look after the money in the fund, all bits and pieces like that. They will vary ever so slightly. The one that we typically use at Morningstar, and this is because it's one of the easiest to find on a fund's factsheet is the OCF. So, if in doubt, do look for these three letters and that will help.

So, let's look at how fees can eat into your money just to show why this is important. So, let's pretend we have £100, and one person invested in a fund charging 1% and the other person invested in a fund charging 0.5%. After one year, we'll say that fund hasn't grown at all, but you still have to pay your charges. So, the 1% is £1 you would have paid in fees. So, you get back £99 if that fund didn't grow at all. This person would pay 50p in charges and they'd get back £99.50. So, all in all, this person probably a bit happier than this person. Ideally, we'd have a fund that just delivered some growth as well. So, this starts to have a real impact when we look at it over the long term. So, if you remember compound interest and how that supersized our gains over 10 and 20 years. This does the reverse. Fund fees are like reverse compound interest.

So, let's have a look at another example. So, we're going to have £10,000 that we invest in a fund. We're going to take quite extreme examples here. So, we'll have one fund that charges 1.5% and one fund that charges naught 0.5%. And we're going to assume that this fund grows by 10% every year, which is obviously pretty good growth. We would be super happy with that. It just helps the figures in this instance, helps me do them a bit more easily. So, after one year, this person would have paid £150 in charges. So, that comes out of the return. So, what they actually get back after a year is £10,850, because that's a 10% growth minus their charges. This person only paid £50 in fees though, so they get back £10,950 – happy customer.

Let's look at it over the long term, 10 years, and we're still getting this growth every year. So, that's compounding the growth and these fees are also compounding on the other way. So, after 10 years, this person has paid £3,328 pounds in fees. So, they're going to get back £22,610. It's not bad, is it? Just leaving your money there. This person, however, is getting back £24,782, because they've only actually spent just over £1,000 on fees. Let's do it even longer term further into the future. This is my retirement fund, 25 years. This person is going to have paid £31,000 in fees. They still get back quite a tidy sum £76,868. So, that doesn't sound too bad on the surface. But what about if I tell you that this person over that 25-year period only spent £11,000 on fees, and they've marched off into the sunset for retirement with £96,682, all because they found a cheaper fund.