The Cost of Investing

30Apr08

Investing is easy, but investing smart is a whole different ball game. There are plenty of hidden fees’ brokerages, fund managers, and financial advisor’s don’t tell you about which can seriously eat away at your returns.

Account Minimum Fee’s

These are usually spelled out for you, but if you don’t like reading pay attention. When investing in mutual funds you’ve probably already invested the minimum opening amount of say $3,000 if you’re going with Vanguard. What you might not know is, you will be charged $20/yr if you have less than $10,000 in your mutual fund. Ouch. $20 of $3,000 isn’t much but if you don’t plan on investing more into that fund it can really add up over the years.

How to Avoid Account Minimums

Meet the minimum. No shit Sheehan. Most fund companies waive these fee’s if you sign up for electronic delivery of statements. What does that mean? It means you get the prospectus, transaction histories etc. all in your e-mail instead of snail mail. That sounds good to me, because all I ever get in the regular mail is spam.

Purchase & Redemption Fee’s

Some funds require you to pay around 1%-2% for investing in their fund. If you want to put in $1,000 that means only $980 will be invested assuming there is a 2% purchase fee. Usually this fee gets paid directly to the fund itself, meaning the value of the fund will rise which is good for you, because you now own a part of the fund. In other cases the fee will go straight into the pockets of the fund manager who likes to wine and dine.

Redemption fee’s work the same way except you pay the fee when you sell instead of buying. How is this different from a front-end or back-end load? There is no difference, unless the fee is paid to the fund itself. In that case it is calculated into the NAV.

How to Avoid Purchase/Redemption Fee’s

Invest in funds that contribute the fee’s to the fund itself. An example of such a fund is the FTSE All-World ex-US Investor Shares. Never pay a front or back-end load. Your money should be working for you, not your fund manager.

Buy/Sell/Exchange Fee’s

If you hold a mutual fund in a brokerage account you might be paying unnecessary mutual fund fee’s. For example, Scottrade charges $17 to purchase mutual funds like the Vanguard S&P 500 Index fund. They also charge $17 to sell that fund, and $17 if I want to exchange it to another Vanguard fund. If you are contributing on a frequent basis these fee’s can be eating up your returns or may even discourage you from investing at all!

How to Avoid Buy/Sell/Exchange Fee’s

Invest with the mutual fund company itself. If you own Vanguard funds, invest with Vanguard. It’s free, no fee’s and they offer better portfolio tracking tools anyways =).

Expense Ratio’s

When you own a fund, every year you must pay the fund manager. He needs his steak. This is called an expense ratio and is a percentage of your account. You can’t avoid this cost, but you can minimize it.

Choose low cost index funds. These expense ratios are between 0.2%-0.5%. Never pay over 1%, your fund manager is simply robbing you. A 0.2% expense ratio on a $10,000 mutual fund is $20 a year. Compare that to a 1% expense ratio which amounts to $100 a year. Do the math please.

Tax Costs

Most people don’t realize this, but if you sell your investment’s before holding them for exactly one year, you are taxed at your regular income level. If you are in a higher tax bracket that means 25%-33%. If you wanted to make a quick buck and made $500 in two months, then assuming you fall into the 25% tax bracket your earnings are really $375.

How To Avoid Tax Costs

Don’t sell your investments within a year. Once you’ve held them longer than a year the only tax you pay is the capital gains tax, which is at 15% right now. Sure beats paying 25%-33%!

Worst Case Scenario

Imagine investing with a brokerage that charges buy/sell fee’s with a mutual fund that charges a front-end and back-end load. You decide to sell the fund early because you wanted to capitalize on the quick gain. These fee’s will seriously cut away from your earnings even if the fund had stellar performance. If you invest smart, and minimize these costs you will earn more on your money.

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