6 Investment Costs You Pay to Play
July 6, 2011
Investing costs can reduce your return on investment and many of us know to try and steer clear of investing fees and expenses. However, avoiding investing expenses can sometimes be easier said than done. For example, the AARP released a report on 401k fees and found that 62% of the respondents didn’t know how many fees they were paying as part of their 401k plan.
Your 401k probably isn’t the first place you think of when you’re factoring in investing fees but it’s certainly one place you should look. Here are some other fees/expenses to keep in mind when you’re adding up the costs of investing.
Brokerage Transaction Fees
When you use a brokerage to invest, you will be required to pay fees when you buy and sell stocks, bonds, mutual funds, or ETFs. This is a fee you pay in order to cover the costs of facilitating the investment transaction. Some brokerages charge a percentage of the principal trade as a fee. Most online brokers, though, charge a flat fee. Each time you make a trade, you will have to pay a fee.
Mutual Fund Load Fees
If you invest in certain mutual funds, you’ll have to pay load fees. These are also sometimes called sales loads. These are special fees charged when you make a purchase, usually meant to pay the broker. You may also see a back-end (deferred) sales load. This is a fee charged when you sell your shares, and usually goes to the selling broker. You might also be charged a redemption fee that is paid to the fund to offset costs to the fund when you redeem your shares.
Operating Expenses on Funds
Many funds include operating expenses. These fees are usually higher in actively managed funds than in index funds or ETFs. This is because the management fee is bigger for an actively managed fund that makes use of a money manager. You might also need to pay distributions fees, which cover marketing fees and shareholder service costs. There are a number of other expenses that may be factored in. The total annual fund operating expenses are often lumped together in an “expense ratio” that can provide you with information about how much of your money will be used to pay costs.
No-Load Fund Expenses
Even if you decide on a fund that’s a no-load mutual fund, it is important to note that you will still incur investing costs. You may have to pay transaction fees and redemption fees, and there will still be operating expenses and other costs. Make sure you read the fine print about the types of fees you can expect to pay; you aren’t fee-free just because your fund doesn’t come with load fees.
Capital Gains Taxes
You will also need to pay taxes on your gains when you sell shares, whether you are selling shares of a fund, or of an individual stock, or some other investment. You are taxed on your earnings. Short-term capital gains taxes are levied on investments that have been held for a year or less. You are taxed at your marginal tax rate for these earnings. Long-term capital gains taxes are for those investments that you have held for at least a year and a day.
The tax rate on long-term capital gains is capped at 15% in 2011, and is expected to rise in 2013 to 20%. Your long-term capital gains rate depends on your normal tax rate. Right now, those in the 10% and 15% tax brackets pay no long-term capital gains. You should also realize that you will have to pay capital gains taxes on gains made during the year when the fund makes trades. Mutual funds trade securities, and those capital gains are distributed to owners. So, you will have to report those earnings as capital gains, and pay taxes on them, even if you haven’t sold shares in the mutual fund.
When you use an investment adviser, you will have additional fees. You might pay asset management fees, which usually amount to a percentage of the assets under management on your behalf. Other advisers might charge a flat fee, for reviewing your portfolio, or for performing other services. In some cases, you might pay a flat retainer fee each quarter or year (it might be broken down by the month as well).
Remember that your investment adviser fee will be an investing cost on top of the other costs. You will be charged transaction fees and fund fees just as you would normally, and you will have to capital gains taxes. Be aware, too, that some investment advisers are paid commissions for selling you certain investment products. This is one reason why some investors have switched to the fee only model mentioned above, to try and avoid conflicts of interest.
Before you invest, check into the fees, and look for ways to cut back on what you’ll have to pay. Of course the saying “you get what you pay for” also applies to investing services and advice. You may be willing to pay more based on your investing needs. Just make sure you understand what it is you’re paying for and that you really need those features, assistance, and expertise. The costs you pay to invest eat into your returns, and can make a big difference in the value of your portfolio over time.
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