Apologies for the extended absence, I've had a lot on my plate the last few months so the website has, unfortunately, had to take a back seat. I'm starting to free up some time again, so after getting the site back up to date I'll start answering the growing backlog of questions you've been sending in - if you're waiting, sorry for the delay, but it will get answered over coming weeks.
One of my first updates has been our Guide to ISA Discount Brokers, which compares the deals and services of 27 brokers. The comparison now uses a basket of 8 popular funds and incorporates any additional broker charges into an effective annual rebate figure - which should make it a lot more useful. Please take a look and let me know if you have any feedback or suggestions.
While all the brokers featured usually offer a saving versus buying direct from fund providers or via commission-based financial advisers, I'm surprised at the variation in discounts offered between the brokers themselves - it could run to thousands of pounds for some customers.
I also find it surprising that some discount brokers retain customers, as they appear to provide very little in return for taking full trail commission. They're probably benefitting from customers who can't be bothered to move elsewhere for a better deal - the same reason that props up a significant proportion of the financial services industry!
Anyway, this is probably an opportune time for a quick recap on how fund charges, commissions and discount brokers work.
Initial charges & commissions
Most unit trusts and oeics levy initial charges, typically between 3% - 5%. These come out of the money you invest, so put £10,000 into a fund with a 5% initial charge and your investment will only be worth £9,500 at the outset.
From this initial charge most fund providers pay a 3% sales commission to financial advisers and brokers.
It's actually a little more complex, as at any point in time unit trusts normally sell units at a higher price than they'll buy them back for - the difference is called a bid-offer spread. While the initial charge usually makes up the majority of the spread, any residual amount is effectively a further cost you absorb when selling units. If you want to read more on this take a look at the charges section on our unit trust page.
Annual charges & commissions
Unit trusts and oeics charge annual management fees. These can vary from less than 0.3% for tracker funds to 1.5% or more for actively managed funds.
The breakdown of a typical 1.5% annual management is as follows:
- Fund manager revenue 0.75% (covers managing funds, marketing, running business & profit etc).
- Sales commission 0.5% (paid to financial advisers/brokers).
- Administration 0.25% (potentially paid to fund supermarkets/platforms).
Funds also incur other costs such as custodian and audit fees, which can add another 0.1% or more. These costs, along with the annual management charge, are reflected by a fund's total expense ratio (TER).
Note, a TER does not include ongoing dealing costs, i.e. the fees paid to stockbrokers (and any stamp duty) every time the manager moves from one share to another. Depending on the extent a manager changes their holdings, these costs could exceed a percent or more a year - a drag on fund performance.
The ongoing ('trail') commission is paid to the adviser/broker listed as 'agent' on the fund. This means that even if you've never heard from an adviser who sold you a fund years ago, they might still be pocketing the trail commission.
If you're getting nothing in return for the trail commission then it's straightforward to either appoint another financial adviser as the agent (to hopefully get some service) or reclaim the commission yourself via a discount broker.
How discount brokers work
Discount brokers simply stamp your fund application form with their 'agency' details (electronically when buying online), collect any sales commissions and pass onto you. In return for this service they'll usually charge a nominal fee or keep some commission.
Initial commissions are normally used to offset initial charges, meaning most funds can be purchased with no initial charge via almost all discount brokers.
Trail commission discounts vary between zero and all of it, depending on the broker you use. Any discounts are usually given as a cash rebate, either direct to your bank account or via a fund supermarket cash account. As the potential savings from trail commission discounts can exceed those from initial commissions over time, it's foolish to ignore them.
Some discount brokers also publish fund research and/or guidance material - ranging from genuinely useful to blatant marketing bumf.
To appoint a discount broker as agent on your existing investments you just need to sign a simple letter or form saying so.
Discount brokers & fund supermarkets
A discount broker might tie themselves to just one fund supermarket. Not a major problem if all the funds you want to buy are available, but potentially limiting - especially if you already own funds via a different fund supermarket.
If you plan to hold funds via more than one fund supermarket (or directly with fund groups) then you might want to check whether your chosen discount broker will provide you with 'consolidated' valuations (both paper and online), allowing you to see all your fund investments in one place.
Three discount brokers (Alliance Trust Savings, Bestinvest and Hargreaves Lansdown) run their own fund supermarkets. This should make little difference in practice, except that if you subsequently decide to move to another discount broker you can't simply transfer the 'agency' - you'll instead need to physically move ('re-register') your funds which is both tedious and potentially expensive. It also means the broker picks up the 0.25% or so platform fee paid by fund managers, although only Alliance Trust seems to use this to enhance some trail commission rebates.
What if I just want to buy shares in an ISA?
If you only wish to hold shares (or gilts/corporate bonds) within your ISA then a low cost online stockbroker will likely be the cheapest route. For example, x-o.co.uk charges just £5.95 per trade with no charge for an ISA wrapper - read our review here.
Which discount broker is best?
It really depends on what type of service you want. Cavendish Online remains the cheapest for most investors, but expect a 'no-frills' service. If you have a larger portfolio and/or want to hold shares alongside funds then Alliance Trust Savings also looks very good value. Hargreaves Lansdown provides lots of information/research, but looks increasingly uncompetitive with stingy rebates and fees for non commission paying funds such as trackers. I can't vouch for the service of any of these brokers, but a look in our user reviews section shows generally favourable feedback.
I suggest taking at look at the comparison tables in our Guide to ISA Discount Brokers then work out which is most likely to be best value for your needs.
And if you're not comfortable choosing funds yourself then consider using an independent financial adviser. Yes, it'll cost more, but it may prove money well spent if you're lucky enough to find a good one.
More about Unit trusts and charges.
Guide to ISA discount brokers.
Guide to trail commission rebates.
Guide to fund supermarkets.