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Dickens, compound interest and fund charges

However, another Dickens' quote is more relevant for investors. This is from Bleak House: "The father of this pleasant grandfather, of the neighbourhood of Mount Pleasant, was a horny-skinned, two-legged, money-getting species of spider who spun webs to catch unwary flies and retired into holes until they were entrapped. The name of this old pagan's god was Compound Interest. He lived for it, married it, died of it."

Compound interest is the friend of the long-term investor. It arises when interest is added to the sum invested, so that, from that moment on, the interest that has been added also earns interest.

However, it is also the friend of the product provider. If charges or commissions are taken each year as a percentage of the investment, then the effect of compounding increases charges over the years.

Low-cost fund manager TCF Investment found that an investor with £10,000 over 20 years in a typical equity Isa fund (with a total expense ratio of 1.7 per cent and trading costs of 1.1 per cent a year) has seen their fund grow by £12,770 to give a final value of £22,770. But the fund management industry has destroyed £15,927 of value through the impact of charges. So investors should reduce charges where possible. The problem is that, in the case of managed funds, establishing what the true charge is in the first place is rather difficult.

The total expense ratio (TER) on funds is the best cost measure that investors have - it combines the fund manager's annual management fee with administration charges for things like custody. However, the TER has long been under attack for not revealing underlying trading costs. This came to a head this month, with two high-profile calls for fund fees to be laid bare.

Wealth management firm SCM Private (backed by Which?) has launched a campaign for "True and Fair" fund labelling, while Fidelity has become the first major UK fund manager to call on the industry to adopt a new measure of investment charges. It proposed publishing a 'total cost of ownership', combining annual management charges, advice fees and platform distribution costs. Read more about this, and the reaction from the Investment Management Association, which represents the open-ended funds industry, in this week's Big Theme.

The problem is that we are dealing with many types of investor. Some will purchase a fund direct from the product provider, prompted by an advertisement. Others may buy funds via an independent financial adviser and be happy to pay a fee for the advice received. Both of these less informed investor groups may have little idea of the compounding effect of charges.

If you are reading Investors Chronicle, you are probably making your own investment decisions, wary of funds that are marketed heavily, and reluctant to pay for advice. I expect that you have a good grasp of the importance of reducing charges on your investments, since charges are the one element of investing that you can control.

Setting aside recent proposals for new charging measures, a good first step would be to ensure that fund providers disclose the TER upfront on their funds' fact sheets. Many otherwise excellent funds fail to do this - you often have to dig deep into the small print of the fund's prospectus to find the TER. But the TER, flawed as it is, is crucial information for investors and should not be hidden away.