Making the most of your investments

A number of articles published in Smart Money in recent months have highlighted how costs and charges can erode investment returns.

Paul Lothian, director of Verus Chartered Financial Planners, highlights a few ways to cut the cost of investing in capital markets.

1 KNOW WHAT YOU ARE PAYING

Before investing make sure that you fully understand the costs involved. Most collective funds (such as unit trusts and investment trusts) will levy an initial charge (up to 5.25 per cent) as well as an annual management charge (AMC). The AMC does not fully reflect the total ongoing costs to the investor, however. A fund's Total Expense ratio (TER) is a better, albeit still incomplete indication. You should also ensure that you understand how much commission is being paid by the fund manager to your adviser or intermediary, if you are using one.

2 THE PASSIVE APPROACH

With most actively-managed funds failing to outperform their benchmark over the longer term, why not just track the index to ensure market returns are obtained?

Typically, index-tracking funds cost from 0.5 per cent a year, while their actively-managed equivalents frequently cost 2 per cent a year or more. Index-tracking funds, which aim to replicate the returns from a particular index, have proliferated in recent years and now cover most asset classes and market sectors.

3 EXCHANGE TRADED FUNDS

ETFs are similar to index-tracking funds in that their price reflects movements in an underlying index, sector or commodity, but they differ in a number of ways. They are traded in the same way as shares on an exchange, so unlike other funds they can be bought and sold for their current market price during the trading day.

ETFs can offer lower annual expenses than even the cheapest index-tracking funds. For instance, the iShares Sterling Corporate Bond ETF has a TER of 0.2 per cent a year.

4 USE A DISCOUNT BROKER

For DIY investors, companies such as Hargreaves Lansdown, Bestinvest and the Share Centre offer access to investment funds with the initial charge being heavily discounted, often to nil. Investment advice is not generally available in conjunction with these offers, although their websites offer detailed information and most maintain a list of their analysts' favourite funds.

5 USE AN INDEPENDENT FINANCIAL ADVISER

Good IFAs will have access to a fund platform where rebates or discounts are passed back for the benefit of the investor. In most cases, the only initial charge will be the IFA's fee for advice and implementation, which should be agreed with you. The best investment platforms "unbundle" the costs of fund management, platform costs and adviser fees, so that clients know who is taking what from their investments.

6 NEGOTIATE FEES

Everything is negotiable – if you have a considerable sum to invest, negotiate to ensure that you obtain fair value from your financial intermediary. Fees vary hugely across the financial services industry, but anything more than a 3 per cent initial fee is too much. Reputable IFAs will reduce their initial fee for larger cases, often down to as little as 0.5 per cent. Better still, agree a flat fee for their involvement.

7 AVOID STRUCTURED PRODUCTS

These products are offered most prominently by the high street banks, but generally offer poor value to the investor as well as often being complex and opaque. Most products will offer returns linked to a share index (most typically the FTSE 100), but investors often fail to realise that they will not enjoy the dividend income from the underlying securities. On a five-year investment, those dividends might amount to as much as 15 per cent and that is the true cost of the limited capital guarantees that these products promote.

8 BUY AND HOLD

There are usually costs associated with switching funds and almost certainly in switching product providers. Try to limit such activity. The same is true for share portfolios – over-trading is more likely to diminish than increase returns, but DIY investors and stock-brokers can often miss this important fact.

9 REVIEW CASH HOLDINGS REGULARLY

Cash plays an important role in wealth management, but it's vital that cash is actively managed to ensure it is obtaining a competitive return. As poor interest rates are the true potential cost of cash, don't fall into the habit of depositor lethargy on which banks and building societies profit.

10 INVEST IN PLANNING

Money spent on engaging the services of an experienced and highly-qualified financial planning professional is one cost that should be recouped with interest. Have your investment decisions put into the proper context of your financial and lifestyle goals by having a financial plan designed and implemented. This way, you will not take any unnecessary financial risks and will benefit from regular reviews.