Day 4: Min(Fees) - “Investment Fees Matter”

 

Now let’s turn our attention to a less exciting topic: the cost of investing. In investing, a penny saved is a penny earned.  Only net returns matter! Recall that the ultimate goal of any investment is to implement the formula

max(Net Return) = max (Gross Return) - min (Total Cost),

where Total Cost refers to all of the costs incurred to make an investment, which includes the cost of the investment, plus any broker commissions, taxes, licenses, and fees related to the asset management and transactions. The good news is that cutting costs while introducing a cost-control system is a sure-fire way to improve the profitability of your portfolio without taking on any additional risk.  You may want to examine each of these categories of expenses and minimize them wherever possible:

1. The expense ratio

The expense ratio is calculated by dividing total fund costs by total fund assets [1]. It includes annual operating costs, including management fees, allocation charges, advertising costs, etc. of the fund. The lower the expense ratio the better because it means that an investor is receiving higher returns on their invested capital. For example, if you invest in a mutual fund with a 1% expense ratio, you’ll pay the fund $10 per year for every $1,000 invested. That’s why   it is advisable that you look at funds offered by other brokers, as switching may offer enough of a savings to be worth the hassle.

2. Advisory fees

An advisor fee is a fee paid for professional advisory services on matters related to money, finances, and investments. It can be charged as a percentage of total assets or it may be associated with a broker-dealer transaction in the form of a commission [1]. It is important to understand that the quality of the advice you receive may be affected by the advisor’s compensation model (fee-only, commission-based, etc.)

3. Investment manager fees

Management fees, whether paid as a mutual fund expense ratio or a fee paid to a financial advisor, can range from 0.10% to over 2%Fees change often to meet market needs. The published list fee is rarely the actual paid fee. With Fee Analyzer [84], you can tap into actual, post-negotiated manager fees—extracted from active portfolios. 

4. Loads and commissions

A load is a commission charged to an investor when buying or redeeming shares in a mutual fund [1].  A commission is a service charge assessed by a broker or investment advisor for providing investment advice or handling purchases and sales of securities for a client.

5. Custodian fees

Custodial fees are costs that you'll pay to a bank or brokerage for taking care of and managing your investments. These could include bank trust departments or registered broker-dealers. These fees, along with other account charges, make up your total expense ratio.

6. Trading fees

Brokers and investment advisors often charge clients commissions for using their services. These are also called trading fees. They basically pay for any investment advice or to execute orders on the sale or purchase of securities including stocks.

7. Platform fees

An investment platform is essentially an online service which allows you to buy, sell and hold funds. Having online access also allows you to view and monitor the progress of your investments at any time. 

8. Stamp duty

Stamp duty is the tax governments place on legal documents, usually in the transfer of assets or property [85]

9. Transaction costs

Transaction costs are the payments that banks and brokers receive from buyers and sellers for their roles [1].

10. VAT

VAT is the tax you pay on something you buy, which usually adds 20% to the price, although there is also a 5% and 0% VAT rate. Several recent CJEU decisions are relevant to the application of the VAT exemption for companies managing special investment funds [86].

11. Capital gain taxes

Capital gains tax is an extra tax on the profit when you sell an asset that is increased in value [1]. So stock shares will not incur taxes until they are sold. The rates are 0-20%, depending on the taxpayer's tax bracket for FY. 

12. Tax on interest and dividends

Dividends and interest are liable to taxation at a flat rate. However, the taxpayer may opt to be liable to tax on dividends and interest received at the marginal rates varying between 0% and 50%.

13. Software license fees

Software licensing agreements (SLAs) are the very heart of software asset management that can provide initial savings of up to 20%. At this level, even single-digit annual savings are very attractive and one of the key aspects to maximizing value for your software IT investments.

14. Open-source products

Open source software is freely licensed to use, copy, study, and change the software in any way. This is in contrast to proprietary software, where the software is under restrictive copyright and the source code is usually hidden. However, certain parts of the open-source software are often made as premium features that need to be paid for. With this, you actively support the maintenance and further rapid development of the product.

15. BI reporting automation

BI reporting is an integral part of portfolio management. Reporting automation reduces the manual work required in generating reports and the margin of error significantly. The most basic way of reporting and related FMR test automation is to measure how much QA time it saves.

16. Excessive services

When reviewing your online account, look out for these red flags that may indicate excessive trading at investors’ expense (churning) [1,9]: excessive fees and frequent/unauthorized trading. In addition, you are skating on thin ice while replying on subscription services thanks to technology and the internet.  These services can inflict more damage to your finances than other types of purchases since they are set up to charge your credit card automatically (and usually for small amounts).

17. Account fees

The trend of commission-free, online trading platforms makes investing more accessible to more people, especially as account minimums disappear. It is important to understand that when an online broker offers commission-free trading, it really just means they don't charge their own fee for helping execute the trade. There might still be other fees involved.

18. Currency exchange

Currency movements could have a significant impact on the performance of your portfolio. A stronger economy generally implies a stronger currency, as confidence in the country’s prospects rises among global investors and they become more inclined to buy assets denominated in that currency. So, when investing in foreign markets the currency movement will increase or decrease the return on the asset itself. As the rise and fall in currencies affects earnings and dividend prospects, it will shift share price valuations and prices. Finally, investing in currency involves buying the currency of one country while selling that of another. This is done through the foreign exchange market (forex) where world currencies are traded 24 hours a day [1]

The Bottom Line: there are numerous ways to reduce fees & costs in your investment portfolio (a commission-free brokerage, free bank accounts, low-cost ETFs, a free robot-advisor , etc.).  In today’s world of financial transparency, it’s easier than ever to minimize your fees and  hidden costs while avoiding mutual funds that charge fees.

Comments

  1. Day 4: Min(Fees) (Zero-Fee Trading Path - “Different Strokes for Different Folks”)
    Here, the goal is to minimize/eliminate both the visible and hidden costs in your investment portfolio. The challenge is that numerous fees associated with the investment journey are often multidimensional and not always as transparent as they could be [71]. You need to understand all the costs associated with your investment reserves as well as the services being provided.

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