All investors can hope for is to try to get a true picture of the costs and then decide whether to buy. You may be able to reduce costs by buying UK direct shares, but if you are investing in overseas shares, many Investors Chronicle readers report that they are left out of pocket by the spreads on the exchange rates (please email me at moira.oneill@ft.com if this has happened to you).
While exchange traded funds (ETFs) can be a cheap way of getting exposure to overseas shares, there is no chance of outperforming the index. But investors who choose active funds in the hope that they will benefit from better performance are often hit by performance fees and the costs of trading within the fund. Even if you can drill down to find out the true picture of costs on active funds, this usually comes in the form of a percentage charge on your investment.
Percentages are easier to dismiss than pounds and pence because they obscure the end result. It may seem logical to say: "I'm going to try to get a 6 per cent annual return on my funds and I'm willing to pay 1 per cent of that return to the manager who I think has the best chance of getting me that return." But let's look at the actual monetary effect of those percentages on a £10,000 investment.
You hand over your £10,000 to the fund manager. After 10 years of consistent 6 per cent annual return, the manager has turned your £10,000 into £17,908. But every year (for simplicity's sake we make this the end of the year) you have paid out 1 per cent of your fund as an annual fee to the manager. That 1 per cent annual charge comes to £1,393 over the 10 years, equivalent to 17 per cent of the £7,908 gain.
The compounding of returns that has been the friend of the investor has also been the friend of the fund manager.
But the compounding of annual management fees on actively managed funds is just the tip of the iceberg - the bit we can see easily. Less visible beneath the waters lie many 'hidden' factors. One of the largest of these is fund dealing costs that are not included in the manager's fee.
Along the way, the fund manager will have incurred costs in buying and selling the underlying investments in the fund. This is reflected in the portfolio turnover rate.
Research into average portfolio turnover rates is thin on the ground. The most recent data I could find is a report by Lipper, which found that the average annual portfolio turnover rate on a UK equity fund is 59 per cent. This can add considerable costs as every time the fund manager buys or sells a holding he pays at least 1 per cent.
Since 2011, fund groups have not been required to report their portfolio turnover rate - a step backwards for transparency.
However, new calculator http://www.trueandfaircalculator.com shows the total cost of investing - in pounds and pence - taking into account an estimated portfolio turnover rate. Anyone considering investing in a fund should visit the calculator first to see how much their investment (there are 3,187 unit trusts, 574 investment trusts and 508 ETFs on the calculator) could be reduced over the years based on the total costs.
Say you put this year's individual savings account allowance of £11,520 into Invesco Perpetual High Income fund, which has relatively low portfolio turnover, and it grew on average at 6 per cent a year. The calculator shows that over five years your investment would have grown by £3,227, but over the same period you would have incurred total costs of £1,410 - that's 43 per cent of your growth.
If you opt for funds with higher portfolio turnover, you could be giving up more than half your growth in costs.
