Money: Show entry fees the exit

By Mark Fryer

If you're the sort of investor who likes the convenience of unit trusts, but isn't so happy about the up-front fees most of them charge, there's a simple answer - don't pay.

Most of the fund managers who run unit trusts can charge an "entry fee", typically up to 5 per cent of your investment. That means that for every $1000 you put into the fund, only $950 actually gets invested.

But unlike most of the other bills we face every day, those up-front fees are largely optional.

Not only are many financial advisers prepared to negotiate over those charges - which they'll often describe as "brokerage" or "commission" - there are also several discount services which allow you to put your money into managed funds with no initial fee at all.

The reason fees are so flexible results from the way that the managers who run unit trusts, and the advisers and others who sell them, make their money.

Most funds can charge two types of fee - the up-front fee when you first put your money in, and a management fee, which is regularly taken out of the fund.

When you pay an up-front fee, some managers keep part of it for themselves, but most give all or the majority of the money back to your investment adviser, as a reward for choosing their fund. As well, fund managers pay advisers "trail commissions" - typically about 0.25 to 0.35 per cent of the value of your investment every year, for as long as you keep your money with that manager.

Which is where the room for flexibility arises. Many financial advisers, brokers and others - "intermediaries" in the jargon - are prepared to reduce their initial fee in return for the continuing stream of trail commissions they can earn from your investment. While 0.25-0.35 per cent may not sound like much, that money can keep flowing in for years, and if the value of your investment rises so will the size of those commissions.

All of which means potential savings for investors. If you can avoid paying the up-front fee, all your money gets put to work for you, and if you're investing a large amount, a saving of up to 5 per cent can be substantial.

If you're dealing with an investment adviser, negotiation is the key. "Negotiate everything," says Wellington sharebroker John Reuhman, who sells managed funds with no up-front charge.

Just because the fund or funds the adviser recommends can charge up to 5 per cent in initial fees, don't assume that's cast in stone.

There are times when you may be better off paying the fees. Especially if you don't have a large amount to invest, an up-front fee may be a cheap way of getting expert advice.

But, particularly if you are a larger investor, you may be much better off beating down the up-front fee or paying for your advice in some other way - perhaps a flat fee or an hourly charge.

And if you're the sort of investor who is happiest listening to your own advice, there are even cheaper options.

Several discount services now provide entry to many funds with no up-front fees at all. They cut costs by offering a limited service and rely on trail commissions for their income.

The technique is simple - the discount service provides you with a list of funds, you tick off the ones you like the look of and they send you the relevant prospectuses. You decide which fund you want to invest in, fill out the form in the prospectus and send it and your cheque to the manager - not to the discounter - along with your cheque.

Not all funds will be completely free, since some managers keep a portion of the up-front fee for themselves, but the discount services provide a wide range of funds from many of the well-known managers, with no or very low initial charges.

Essentially the discounters do nothing more than distribute prospectuses, and once they've done that they're out of the picture - apart from sitting back and receiving their regular commissions.

Why not just go direct to the fund manager? While some managers will deal directly with the public, others won't, and many will charge you an up-front fee. That's their way of avoiding being in competition with the financial advisers and others they rely on to sell their wares.

The obvious disadvantage of going the discount route is that you're travelling alone. The discounters don't offer advice, so there's no-one to hold your hand and help find the best fund or funds to invest in.

The sort of people who are happy with that approach are "clients who can read, synthesise information and make their own decisions," says Reuhman.

While some of his customers have been known to invest sums well into the six figures, discounter John Commins, who runs the Global Register service, says the discount approach also appeals to many small investors, including those who want to make regular "drip feed" payments into a unit tust.

With hundreds of managed investments available, choosing the right fund can be a challenge for the novice. Ratings of the various funds, such as those published every weekend in the Business Herald, can narrow the field, but it can take a lot of research to decide were to invest.

It's also worth remembering that just because an investment is free doesn't automatically make it a good deal. Keep in mind the tax disadvantages of actively managed unit trusts compared to some competing investments such as passive funds and investment trusts which are listed on the sharemarket.

And don't let the absence of up-front fees blind you to the other fees the funds charge. The regular management charge may be invisible, because it's taken out of the fund rather than charged to you directly, but it still comes out of your pocket. Over the long term, those fees can cost you more than the up-front charge, so it's important to compare management charges when deciding what fund to put your money into.

But if a unit trust is what you want, and you're confident enough to make your own choices, the discounters offer a way to get your investment off to a flying start.