Investing may bring better returns but watch out for costly structures
Deposit rates may have plummeted but regular investment products have soared; but investors should do their homework before allocating
It all adds up: working out how much you have to invest each month will be important. Photograph: iStockphoto
With deposit rates continuing to offer savers little comfort, people looking for a better return on their money will have to think about something else. One option to consider is swapping your regular savings account for a regular investment product.
But don’t rush for greater returns without doing your homework first.
Yes, you may be in line for greater returns but, thanks to hefty management charges, policy fees, early withdrawal fees and entry and exit levies, it may be more expensive than you would have envisioned, and make those simple – and risk-free – deposit accounts look a bit more attractive. When you factor in the Government levy (1 per cent) plus annual charges of up to 1.85 per cent, your fund might need to return almost 3 per cent just for you to break even. Add in other charges and it may be a risk you just won’t want to take.
The number of regular investment products on offer have soared as deposit rates have plummeted, with KBC Bank the latest to enter the fray with its new Start2Invest product.
Products from life companies are also plentiful, while setting up a scheme with a stockbroker is also possible.
Be aware, however, that one player, Rabodirect, is exiting the regular investments market; if you’re already a customer of the bank, you can withdraw your funds by April 24th next and avoid any exit charge (normally 0.75 per cent). If you wish to keep your fund, you can transfer it to Cantor Fitzgerald Ireland.
From an investment perspective, regular investment products have a key advantage over the lump-sum equivalent – they allow you to “average-in” to the market, thereby providing you with a bit of protection from troughs as you’ll be buying in at a different price each month.
The options are plenty: New Ireland has 52 different funds to choose from on its platform and Zurich Life 49, and they’re just two of the many players in the market.
A key consideration when sifting through the myriad competing products is finding a product that offers the investment you require. If you’re looking for a simple US equity fund, the options are plentiful but not all providers will have the same options so take your time to consider your needs.
Working out how much you have to invest each month will be important. Like regular savings accounts, some of these products allow you to start low. New Ireland, for example, requires you have to €200 a month, while you can start investing with as little as €75 a month at Zurich, with no maximum limit. Some other fund providers do have limits: €5,000 a month at New Ireland and KBC and €10,000 with Irish Life.
Compare annual management charges
Unfortunately, there is still no handy way of comparing fund charges in Ireland, such as a total expense ratio (TER), but a good place to start is the annual management charge, which is likely to be the biggest drain on your fund.
The charges vary substantially. At New Ireland, for example, fund charges start at 0.75 per cent, but its BNY Mellon Global Real Return Fund has an annual charge of 1.85 per cent. Essentially, your fund will have to return this amount just for you to break even.
Part of the problem lies in the fact that many Irish fund providers simply offer funds managed by third parties. That means there are more intermediaries, each of whom is looking for a fee, which can drive up costs. Rabodirect for example, received between 50 per cent and 60 per cent of the fund provider’s annual management fee.
Charges can have a sizeable impact on your return over a five-year period, so don’t discount them.
Consider that you save €200 a month over five years, with an annual return of 7 per cent. Investing in a cheaper fund with a management charge of 0.45 per cent, your return would be €14,148 on your €12,000 overall investment. That’s €517, or almost 38 per cent, with the same money earning the same return in a more expensive fund charging 1.85 per cent fund (€13,631).
Of course sometimes it can be worth stomaching a higher management charge to get a better return, while you might also be seeking a particular asset class for diversification purposes. The problem is that it’s impossible to predict with any certainty when you should stomach high management charges to chase a better return.
Should you, for example, pay more to have your fund actively managed, or should you look for the cheapest index tracking fund you can find? Several studies have suggested that active funds as a group don’t deliver greater real returns but, naturally, there are always the exceptions. It’s a constant dilemma facing investors, but in the end it’s up to you.
Another option is to open a stockbroking account. Depending on how much you’re investing and what you’re investing in, you might find it more cost efficient to invest into an exchange traded fund (ETF) through a broker.
Davy’s Select platform, for example, can be opened for a charge of €80 a year. It operates a little differently. You don’t have to invest every month and, when you do, you can invest as little or as much as you’d like, although if you choose particular funds on the platform, you may find similar restrictions to the other providers.
Charges here start at 0.5 per cent, subject to a minimum charge of €14.99 a transaction, when buying shares or ETFs. There are no charges for investing in the 700 funds on Davy’s platform, but they will be subject to annual management charges like other funds, as will ETFs. Davy funds typically have a annual management charge of between 0.5 and 2 per cent, while ETFs can be purchased for as little as 0.15 per cent a year.
Dutch low-cost broker DeGiro, which now operates in the Irish market, allows you to buy ETFs commission free, but you will pay an annual fee per exchange, of up to €2.50 (the Irish Stock Exchange has no such fee). This could prove to be far more cost effective than a traditional life product.
It’s not just about annual management charges. Fund providers can levy fees in a host of other ways. New Ireland, for example, charges a €25 part encashment fee, as well as early withdrawal charges of as much as 5 per cent. Zurich Life has a monthly policy of €3, or €36 a year on some of its funds. It may not seem like a lot but, if you’re only investing €75 a month, it’s cutting your allocation by 4 per cent.
KBC Bank’s funds typically have an annual charge of 1.2 per cent but read the small print and you’ll see that the funds are liable to an overall annual charge of 1.61 per cent, due to “additional ongoing charges” of 0.41 per cent.
If you wish to switch between funds offered by a provider, you’ll typically be able to do so free
Another downside of these products is that it’s difficult to time a withdrawal. Say some event is happening in a week’s time (the Brexit vote, US presidential election, for example) and you wish to withdraw your funds fearing markets may slide depending on the outcome of the vote. You can print off a withdrawal form and send it off to be encashed, but life companies typically won’t give you a guarantee on exactly when your units that you’re selling will be priced – which can make it difficult to time your sale exactly when you want to.
If you issue a sell order to a broker on an ETF, you should have more control over the timing.
Beware withdrawing...or stopping your payments
Tread carefully if you’re not sure how long you intend to hold your investment; life companies can impose fairly swingeing penalties if you exit the policy early.
Typically, life companies expect you to hold such a policy for a term of five years or more. If you withdraw your funds after this date, you generally won’t incur any charges. But if you withdraw some, or all, of your investment before this date, however, you will likely have to pay an early withdrawal charge.
With Irish Life, for example, you will lose 5 per cent of the value of your investment if you have to encash it in year one. So, if you have saved €200 a month, you will lose €120 from your €2,400 nest egg.
These charges usually decline in line with the length of time invested in the product, so by year three, for example, the charge will have fallen to about 3 per cent. But by then, by virtue of the additional two years of regular contributions if nothing else, your fund will be worth a multiple of year one – barring a catastrophic collapse – so the charge will hit even harder in absolute terms. This means that even if your fund returned nothing between year one and year three, the fee to exit in year three would almost certainly still be more than €200.
Aviva has recently eliminated all its administrative fees and ancillary charges on its regular saver product, which means that if you opt for its product, you won’t be hit with an early withdrawal fee; the only charge remaining is the annual management fee.
You can also run into problems if you can no longer afford to keep up your contributions. While some providers, such as Irish Life, allow you to take a payment holiday “free of charge”, this is only for a fixed period of time. Thereafter you may have to “withdraw” from the fund, thereby incurring the charges mentioned above.
With other providers, such as KBC Bank and stockbroker Davy, such charges aren’t levied. With Davy, for example, you can invest “as often or as little as you like”.
While Dirt on deposits is set to fall from 41 per cent to 39 per cent, and to 33 per cent by 2020, the Minister for Finance did not signal an equivalent reduction in exit tax on investment funds in the most recent budget. This means that any gains you make will be taxed at 41 per cent – significantly higher than the 33 per cent levied on individual shares, or the aforementioned 39 per cent on deposits. So, a return of €1,000 will mean a net gain to you of just €590.
Under gross roll-up however, funds are allowed grow tax-free until they are sold by the investor, or after eight years, whichever happens first.
If you want to allocate some of your monthly contribution to a property fund, remember that additional restrictions might apply.
For one, you’re likely to pay a higher annual management fee. Aviva’s Irish and UK property funds are 0.25 of a percentage point more expensive than their other funds for example.
Another consideration is that property funds are less liquid than other investments, and the fund provider may ban redemptions, which means you won’t be able to access your funds for a period of time, typically up to six months. In the aftermath of June’s Brexit vote, for example, both Aviva and Standard Life fearing a run on assets barred investors from withdrawing their cash from their UK property funds.
Remember it’s not just about management charges and policy fees when it comes to regular investment products – they are also subject to a 1 per cent Government levy. The levy, which was introduced on life assurance investment policies as part of the Finance Act 2009, is collected by the fund provider. While life companies have called for its abolition in recent times, describing it as “an outdated penal tax”, as long as it’s in place it will cut the value of your fund to the tune of 1 per cent.