For years, I and my colleagues here at The Motley Fool have been urging investors to buy low-cost index trackers.
Today, I’m writing with a rather different message. Namely this: buying low-cost index trackers might not be such a good idea, after all.
I know, you’re surprised. So am I.
But I’d remind you of the words of John Maynard Keynes — who wasn’t only an economist, but also a canny investor who made substantial profits for himself, and for Kings College, Cambridge, where he taught.
And the words in question? “When the facts change, Sir, I change my mind. What do you do?”
Blame the FCA
And sadly, it seems that the facts have changed.
Not for every investor, it’s true. But certainly for the 600,000 investors collectively investing £43 billion with the UK’s leading fund supermarket, Hargreaves Lansdown. And certainly, too, for the clients of many of the other firms jacking up charges in the wake of the Financial Conduct Authority’s so-called Retail Distribution Review (RDR).
Simply put, this resulted in a ban on ‘trail commission’ — the money paid by investment fund managers to those fund supermarket and investment platforms that carried, and promoted, their respective funds.
And with trail commission banned, those fund supermarket and investment platforms promptly lost a handy — and not insignificant — source of income. Income that they’ve busily been replacing by levying charges on their customers. Namely, you and I.
Fee shock
The upshot of all this has been to overturn the economics of investing in trackers.
Take an investor tracking the FTSE All-Share index through Vanguard’s low-cost FTSE UK Equity Index Fund — one of the very cheapest on the market, levying an ongoing charge of just 0.15%.
Or an investor piling into one of Hargreaves Lansdown’s specially negotiated super-cheap index trackers, such as Legal & General’s UK Index Tracker, which again tracks the FTSE All-Share index, and charges just 0.1%. Good value, surely?
But onto these super-low tracker charges, Hargreaves then adds its own management fee, levied to cover its own costs. The fee in question? A whopping 0.45%, which — what’s more — is uncapped for investments of less than £2 million. Not quite such good value.
Tax on wealth
Add the two together, and you’re looking at a total cost in Vanguard’s case of 0.6%, and 0.55% for the Legal & General tracker. Put another way, with the market yielding around 3.5% at the moment, you’re paying around a fifth of the tracker’s dividend income in fees.
Nor is the situation necessarily any better elsewhere. Alliance Trust Savings, for instance, has won plaudits for its ‘flat fee’ charging structure, under which the amount an investor pays doesn’t go up as his or her investments grow.
But at a cost of £18.75 per quarter for an ISA, it’s clear that investors with smaller savings pots would be better off with Hargreaves Lansdown — despite the latter’s 0.45% so-called ‘tax on wealth’.
Simply put, trackers were once a great way for investors to start saving. These days? I’m not so sure.
Check the small print
Now, it’s important to stress that the purpose of all this isn’t to throw brickbats in the general direction of Hargreaves Lansdown and Alliance Trust. Both perform a valuable role in the world of investor education, for one thing, and we should all be grateful to them for that. For customer service, too, both win plaudits.
Equally, they — and other platforms — have businesses to run, and must set their charges accordingly.
But look at the small print of those charges, and you can’t help but see certain advantages to holding shares directly, rather than through a fund or tracker.
Harking back to Hargreaves Lansdown for a minute — after all, the firm is pretty much the 800lb gorilla of UK investing platforms — it’s clear that the firm’s total fee levied on shares held in an ISA is capped at £45 a year. On the other hand, no cap comes into effect with funds or trackers until you’ve amassed £2 million worth.
Put another way, hold £250,000 of shares in a Hargreaves Lansdown ISA, and you’ll pay a total of £45 a year. Hold the same amount in a tracker, and you’ll pay £1,125 a year.
Which is quite a difference.
A DIY tracker?
Now, I accept that this overturns some of the conventional logic around buying trackers, and funds in general.
Collective investments, after all, are supposed to be cheaper. But as we’ve seen, viewed solely in terms of holding shares, they’re not.
Granted, you’ve got to buy the things in the first place — and while trackers and funds don’t generally attract commission (although, post-RDR, that statement isn’t necessarily true), dealing commissions are most certainly chargeable on share purchases.
But take advantage of the platform industry’s widespread use of ‘low-cost trading days’, and monthly regular savings plans, and it’s possible for dealing commissions to be slashed to a figure in the £1.50-£2.50 range.
A DIY ‘build it yourself’ index tracker? Surely you can’t be serious, Malcolm?
Well, last time I looked, the FTSE 100’s ten largest shares made up almost 50% of the market. Which does rather suggest that a holding of twenty or so shares, judiciously chosen, could do a pretty decent job of being a DIY tracker. And at a significant saving.
Food for thought, indeed.
