It’s a question of cost control and is the main issue fund-toting investors must resolve now that sweet-smelling RDR is here to turn the financial advice industry whiter-than-white.
The question comes down to this:
- Are you better off with a portfolio full of investments that siphon off mucky ol’ commission to your broker from the fund fees?
- Or should you go for clean class funds that are superficially cheaper (because they don’t pay commission) but instead force brokers to cake on extra fees to wash their face?
The short answer…
The likely answer is that investors with small portfolios are better off with brokers that still provide old-style commission funded services. If you pick your platform wisely then you can avoid flat-rate charges such as platform fees and dealing costs that take a disproportionate chunk out of a smaller portfolio.
In contrast, investors incubating a large clutch of assets can more easily absorb flat-rate costs. But they should steer clear of percentage fees that swell along with the portfolio.
So how small is small and how large is large?
Let’s find out.
The long answer…
Step 1 is to find out the total Ongoing Charge Figure (OCF) of your portfolio.
Just multiply the OCF of each fund by its percentage allocation in your portfolio. Then add up your results to clock your portfolio’s total OCF.
|Total Market tracker||70%||0.5%||0.7 x 0.5 = 0.35%|
|Property tracker||20%||0.4%||0.2 x 0.4 = 0.08%|
|Gilts tracker||10%||0.2%||0.1 x 0.2 = 0.02%|
|Total Portfolio OCF||0.45%|
If you get commission rebates from your existing broker, don’t forget to subtract those from your fund OCFs.
Now match up the total OCF of your dirty portfolio against the cost of its clean class alternative.
For example, the total OCF of Monevator’s Slow and Steady passive portfolio is 0.37% if using dirty funds.
Multiply your total OCF by the size of your portfolio to find out how much you’re paying in charges.
- £10,000 x 0.0037 = £37 (annual cost of dirty fund portfolio).
- £10,000 x 0.0024 = £24 (annual cost of clean fund portfolio).
Thirteen pounds. That’s all the OCF cost savings on a portfolio of this size amount to for being squeaky clean. If your prospective broker is going to charge you more than that in additional fees, then go down the dirty route.
And there isn’t a post-RDR broker out there who is going to charge you less than £13. So much for RDR helping small investors.
Obviously, if the dirty portfolio is subject to other costs then you should count those too, although that won’t be a concern if you choose a fund supermarket like Cavendish Online.
The breakeven point
So what does it take for the clean class to win? How large does your portfolio need to be?
Continuing the example above…
The difference in OCF cost between a dirty and clean portfolio is 0.13% (0.37% – 0.24%).
We’re looking for the point at which that 0.13% difference is worth more to us than the annual costs we’d incur with a broker selling clean funds.
The broker BestInvest charges £60 a year in custody fees to own clean funds. There are no dealing fees for funds to worry about, which keeps things nice and simple.
The calculation is:
£60 / 0.0013 (or 0.13%) = £46,154
That’s the breakeven point at which the cost of a dirty fund portfolio costing 0.37% a year equals the cost of a clean portfolio costing 0.24% plus £60 in broker charges.
£46,154 x 0.37% = £170.77 total cost
£46,154 x 0.24% = £110.77 + £60 = £170.77 total cost
If your portfolio is bigger than the breakeven then you’re better off in clean class funds.
Make sure you count any annual fees, platform fees, dealing charges and other costs that are relevant to you (perhaps dividend reinvestment charges) and subtract any rebates. Remember to add the cost of multiple accounts if you hold them.
If you invest regularly then you should be able to accurately estimate your annual dealing fees, or else use last year’s pattern. You may also want to estimate your portfolio’s size once you’ve dripped another year’s worth of cash into it.
In for a percentage
Some post-RDR brokers charge a percentage management fee. For example, Charles Stanley Direct charges 0.25%.
That’s pretty simple. Just add that number on to your clean portfolio’s total OCF to see if the total cost is cheaper than the dirty version.
For example, an unbundled 0.24% + 0.25% is never going to be beat the bundled 0.37% fee for the dirty Slow & Steady portfolio.
To compare a flat rate fee against a percentage fee then use the following calculation:
Total costs of broker 12 divided by broker 2 percentage rate
= breakeven point
I’m outta here
If you do decide to switch then make sure you’re aware of the pitfalls of being out of the market if you cash out. Also note that your existing execution-only service may charge you exit fees to leave.
Some investors will be experiencing compulsory conversion to clean class funds, as their broker weans themselves off their commission skag.
But it is uncertain whether the commission-only escape route will remain open for long.
The FSA will rule later in the year on whether execution-only platforms will remain exempt from the RDR ban on payment by commission.
The fact that many firms haven’t gone clean is proof positive that the decision could go either way. Until then, where there’s muck there’s brass.
Take it steady,