Investment fees: transaction costs eating into tracker fund returns

Backing a tracker fund is supposed to be a cheap and relatively safe option, yet some investors face far higher costs than usual.

Investing is not easy. 

The returns are obviously better than what you could get from sticking your money in a cash account, though admittedly that isn’t difficult at the moment.

The big downside, of course, is that things can go horribly wrong and you end up losing every penny you’ve put aside, which let’s be honest is quite a large downside. 

You don’t get that with an ISA, even if it is only paying 0.1%.

Because of the complicated nature of investing and picking winning stocks, many of us opt to put our money into investment funds. 

Funds invest in a range of different stocks and shares.

The idea is that this diversification will offer you some protection ‒ while some firms the fund invests in may have a tricky time, that should be balanced out by the firms performing well, meaning that over time you end up getting a decent return.

What am I paying for?

There is a problem though, which is that an awful lot of funds aren’t managed particularly well.

The people in charge of the funds make some iffy decisions over which firms to back and end up underperforming the indices they are measured against.

It’s something we highlight every year by covering the Spot the Dog report from BestInvest, which flags up the ‘dog’ funds which perform most poorly against their rivals.

Ultimately backing a managed fund can end up being hugely expensive if you pick the wrong one, as you end up paying a significant management fee for a fund that delivers a mediocre return on your cash.

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Putting trust in a tracker

The alternative fund that’s popular with many investors, myself invested, is the tracker fund.

These funds attempt to replicate the performance of a specific index, like the FTSE 100 for example. By investing across the index, the idea is that as the index goes up, your fund will go up by a similar amount. 

Obviously you will never beat the market this way, but the selling point is that at least you’ll never be that far off, making them a relatively ‘safe’ option.

The other big selling point to tracker funds is that they are much cheaper than regular investment funds.

After all, with a managed fund, there’s a manager is being paid for their expertise in picking stock winners (or not, as the case often is).

But with a tracker, there isn’t that decision process ‒ the fund is merely tracking an index, meaning that the fees you have to pay are much smaller.

Or at least that’s the theory. The trouble is that in practice, that isn’t always the case.

Why tracker funds can cost you

The issue comes down not to the ongoing, headline charges of a tracker, but the transaction costs for buying and selling the investments held within that tracker.

And a new study by The Telegraph lays bare just how costly it can be.

It found that a massive £54bn of investor cash was tied up in tracker funds where the transaction costs ‒ which are ultimately paid by the individual investors ‒ exceeded the headline ongoing charge.

Notable offenders here include the iShares Mid Cap UK Equity Index Fund, which has a paltry 0.17% annual charge and yet incurred transaction costs of a whopping 0.67%.

Similarly, the HSBC FTSE 250 Index had transaction charges of 0.36% compared to its 0.12% annual fee.

Why fees have fluctuated

Which of course begs the question of why the transaction fees for some tracker funds have been so monumental over the last year.

The answer, inevitably, is the pandemic. 

As the pandemic hit, plenty of investors looked to pull their money from tracker funds as the markets started to slide. That meant funds selling up some of their stockholdings in order to return the cash to investors.

But then of course, as things started to recover and the markets picked up, investors moved back into the market, which meant those funds had to buy back in too.

This 'hokey cokey' approach meant that for many funds, far greater transaction fees than usual were incurred.

What can I do about it?

The plus point here is that these larger than usual fees have been incurred because of a global pandemic. Thankfully this isn’t a regular occurrence, so in normal circumstances the transaction fees you’ll face are much more modest.

Nonetheless, it demonstrates the importance of looking closely at all of the fees ‒ including the transaction costs ‒ when deciding which tracker fund you want to put your money into.