Would you consider paying five times as much – or even more – for a product that has a worse-than-evens chance of performing better than the cheaper alternative? If you said yes to that question, you’re one of a dwindling number of investors to whom active funds may still seem the only choice.
Passive investment funds, which simply aim to track the performance of a given market, grew 4.5 times faster last year than actively managed vehicles, where a fund manager tries to beat the market, according to the Financial Times. The expansion of Vanguard, the giant US fund manager, in the UK market last month is likely to see that trend accelerate. Vanguard has offered a range of passive funds at bargain-basement prices for several years, but has now launched a low-cost investment platform through which you can hold its funds, further undercutting pricier rivals.
It’s not difficult to see why passive funds are so popular. The statistics vary according to the markets and time periods researched, but there is no hiding from the fact that the majority of actively managed funds, which carry considerably higher fees than passive funds, fail to beat the market. So much so that last November the Financial Conduct Authority, the UK financial services regulator, issued a damning report into the failures of the active management sector – effectively accusing it of ripping investors off.
For retirement investors, this really matters. The effect of high charges, even if investment performance is equal, let alone inferior, is amplified over time. Assume you pay £250 a month into a pension fund entirely invested in tracker funds, where the typical charge today is around 0.2% a year, and make an annual return of 6%. After ten years, you’d have £40,392. The same investment in a fund charging 1% a year, more typical for an active fund, would deliver £38,748, some £1,644 less.
Run that exercise over 30 years, say, which might be the length of your pension plan, and the shortfall comes to £31,244. To put that another way, the active fund charging 1% must outperform a passive fund charging 0.2% by 0.8 percentage points a year just to match it. It’s a tall order, even for active fund managers with impressive long-term records.
The bad news is that Vanguard is not yet offering a self-invested personal pension (Sipp), so investors can’t use its cut-price platform as a one-stop-shop – though the firm says that it will launch a Sipp some time in 2018. However, Vanguard’s exchange-traded funds, which are its cheapest passive products (its FTSE 100 fund has an ongoing charge of just 0.09% a year, less than half what other trackers charge), are available to pension investors with Sipps held on other platforms. Look out too for price cuts on Sipp wrappers from these providers – it’s possible that rival platforms will feel the need to reduce their Sipp charges ahead of Vanguard’s entry into this part of the market next year.
None of this suggests that Vanguard is necessarily the perfect pension provider for all savers – or even for those who have decided that passive investment is the way forward. But if you take the view that it is simply too difficult to pick actively managed pension funds that will consistently justify their higher charges, it makes sense to focus on criteria you can control. Not only is cost top of the list of such criteria, it’s also the factor with the greatest potential impact on your long-term pension returns.
The best platforms for your funds
As mentioned above, Vanguard now sells its low-cost funds directly to investors. The Vanguard platform charges an annual administration fee of just 0.15% for both individual savings accounts (Isas) and taxable investment accounts. If you hold more than £250,000 through this platform, the annual fee will be capped at £375.
As it stands, this is a lot cheaper than most of the UK’s most popular fund supermarkets, including Hargreaves Lansdown and Charles Stanley, which charge 0.45% and 0.25% respectively to hold up to £250,000. However, if you are intending to put a lot of money into a Vanguard fund, it could be cheaper for you to go through a platform that charges a flat fee.
For example, Alliance Trust charges £7.5 per month for an Isa, while iWeb Share Dealing (which is operated by Halifax), charges just a £25 account opening fee for an Isa and no ongoing administration fees. Both also charge dealing fees for buying and selling funds – so if you deal a lot, it may still be cheaper to go to Vanguard.
Vanguard does not yet offer a self-invested personal pension (Sipp) wrapper, so you will need to use a different platform for this. Low-cost Sipps for funds include Bestinvest and Cavendish Online (the latter is a low-cost broker that uses the Fidelity platform but at lower charges than going direct to Fidelity).
Tax tip of the week
Last April saw the introduction of the controversial higher-rate stamp duty land tax (SDLT) due on the purchase of second homes. However, the legislation governing this additional rate did allow for some (quite narrowly defined) exceptions. One such exception is designed to apply to those who have recently inherited a share of a property. If you are in the process of buying a property to move into as your main residence, but already own another property, you would normally have to pay the higher rate.
However, if your ownership in that property only came about because you inherited a less-than-50% share during the 36 months prior to purchasing your new home, the extra 3% stamp duty rate will not apply to the purchase.