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Interactive Investor no longer a friend to passive investors

Thursday saw the Monevator inbox swell up like a Spanish housing bubble. Email after email came in from dedicated readers horrified by the price bomb [1] dropped on their heads by Interactive Investor (the discount broker commonly known as iii).

In one fell swoop, iii swung from being one of the cheapest execution-only brokers around into being about as suitable for small passive investors [2] as mood-altering dance music concealing subliminal BUY / SELL messages.

Let’s quickly recap on what iii has done and why, look at how bad that actually is, and then you can consider some F U iii responses here [3].

A bad day for passive investors [4]

What has iii done?

The investor anguish is palpable, not far off Charlton Heston’s fist-pounding “God damn you all to hell” moment in Planet of the Apes. From 1 July, iii is introducing the following price changes [5]:

£20 quarterly fee

£10 trading fee for all funds

100% trail commission rebates

Previously, iii did not charge a quarterly fee and you could trade funds for free.

Ah, the good old days.

How bad is it?

Frankly, it’s pretty grim. Flat-rate charges always hit small investors hardest. Here’s how much you’ll lose from your return if you pay £80 in extra management charges per year:

Portfolio size (£) Cost of £80 charge (%)
2,000 4
4,000 2
8,000 1
16,000 0.5
32,000 0.25
64,000 0.125
80,000 0.1

The UK stock market has historically offered a real return of 5% per year. A loss of 1% in fees would rob you of 20% of that gain.

That’s why fees [8] matter, even if the percentage cost seems trivial. The loss is potentially huge for current iii customers who are struggling to build up their investments, and there are plenty of Monevator readers in that boat.

If you hold a Slow & Steady style [9] portfolio then you’ll dilute the above costs by around 0.13% a year, thanks to trail commission rebates [10].2 [11]

Then we get to the impact of trading fees

The Slow & Steady portfolio holds a diversified suite of seven index funds that could previously be traded for free with iii.

Contributing to each fund every quarter would cost an additional £50, according to iii’s new pricing plan.

That’s £200 per year – without even thinking about rebalancing [12] sell trades.

If we switched to iii’s monthly investment scheme, we would make £10.50 worth of purchases every month. That would mean paying out £11.50 every quarter on top of the management fee, or an extra £34.50 per year (again without rebalancing).

It’s all far too much to give away. I wouldn’t now give iii a second look unless I had a portfolio worth over £32,000. Even then, there are plenty of better alternatives available.

Infuriatingly, iii has given customers just a month to react to these sweeping changes. I’m sure that fulfills the requirements of its terms and conditions, but it hardly smacks of a firm that cares for its customers. And neither does the disingenuous justification that coats iii’s explanatory email like a layer of slime.

You can read the letter and enjoy it being taken apart by one outraged customer at the Simple Living In Suffolk [13] blog.

We all know that brokers love churn but iii’s claim that its move is in the interests of investors, who it ‘believes’ should ‘actively manage’ their portfolios, feels to me about as sincere as Peter Mandelson thanking his aunt for a Christmas present of Argyle socks.

Why is this happening?

It seems likely that charging higher fees is less to do with an ingenious attempt to help customers ‘engage’ than it is connected to the Retail Distribution Review (RDR) [14].

The RDR is the FSA’s regulatory tsunami that’s been rumbling towards the financial services sector for a couple of years. It finally hits on 1 January, 2013.

A major part of the RDR brief is that product costs should be transparent to investors. That means financial advisors will no longer be able to collect trail commission [15] paid for by investors through fund TERs that see us skip home thinking we somehow got the nice man’s advice for free.

Critically, the FSA has not yet decided whether to ban the trousering of trail commission by execution-only platforms [16] like discount brokers and fund supermarkets. That decision is due before the end of 2012.

Currently, execution-only platforms hoover up trail commission from funds, even though they dispense no advice. That enables the platform to turn a profit while leaving us in a blissful state of ignorance about the true cost of its services.

Brokers like iii and Hargreaves Lansdown [17] appear to have decided it’s game over for trail commission and we might as well all get used to it.

Sadly while this financial glasnost makes a lot of sense, it bizarrely works against passive investors who know how to take on the system.

We aren’t about to get a windfall from active funds full of trail commission fat. Instead, we’re getting stung by the disinfectant of financial reform – just as somebody who’s inoculated themselves against bank overdrafts and loans will when free banking finally comes to an end.

Still, there are plenty of other platforms that are keeping their powder dry, or reshuffling their fees in a more passive investor-friendly way than iii. Take a look at your options here [3].

Take it steady,

The Accumulator

  1. The fee waiver comes with other conditions attached as outlined towards the bottom of this page [5]. [ [22]]
  2. Assuming you hold around 10% in the L&G Global Emerging Markets index fund. That fund offers trail commission of around 0.4% while the other funds come in around 0.1%. [ [23]]