Investing can be a great way to grow your assets and reach your financial goals quicker, but did you know that hidden costs are not just for borrowing money?
Most investments will also have hidden costs that are difficult to negotiate and confusing for the investor to understand.
Luckily, we’ve put together this handy guide that explains the different types of hidden costs that you need to be aware of and consider before investing your money. Which investments might have more hidden costs than others? Let’s find out.
What are the different types of investment costs?
Certain items in your investment portfolio occur higher fees than others. Whether it’s stocks, bonds, mutual funds, property or bank products, your investment may involve one or more of the following hidden costs.
Commission – sometimes called service fees or trading fees, these costs are charged by the investment advisor for providing investment advice. Always ask for a broker’s fee schedule before using their services.
Loads – there are two types of load costs associated with investments. A front-end load is a charge that the investor pays upfront when purchasing an asset. The percentage can vary but is typically between 3.75% and 5.75% of the price of the asset. A back-end load is the fee charged when are investors redeem their mutual fund. It is usually paid as a percentage of the value of the fund’s shares.
Expense ratio – an expense ratio is a cost charged by investors that covers administration and portfolio management. These fees are typically percentage-based and represent your annual cost.
Redemption fees – investors who sell shares will be charged a redemption fee by the fund company which is then added back to the fund. This will usually only apply when your shares are sold within a certain timeframe, however it’s important to check before investing in shares.
Exit fees – an exit fee is common in open-end mutual funds. The investor will be charged when they sell shares of their investment fund. In addition to an exit fee, as an investor you may have to also pay a redemption fee described above.
Marketing costs – for some investments, the investor is charged fees to help cover the cost of marketing and distribution to promote the investment to other potential investors. Also referred to as a 12B-1 fee, this expense is typically between 0.25% and 0.75% of a fund’s net asset.
Taxes – new investors are often unaware that you will need to pay taxes on any profit that you make from your investments. Depending on the type of investment you have and how much it makes, you may be liable for paying income tax or capital gains tax. Some investments may also have special tax treatment depending on the state where you live and the state that issued the bond you are invested in.
Management fee – management fees are paid to professionals or financial advisors who manage your investments in return for advice. This type of fee can sometimes be called advisory fees or investment fees and are usually charged as a percentage of your total assets under management (AUM). If you want to avoid management fees, it’s possible to self-direct your investments but it’s not recommended for inexperienced investors.
Custodian fees – also known as safekeeping fees, a custodian fee is paid to a person or company that manages your investments and are called custodians. Custodians will collect your dividends and interest, provide an account statement and handle any other tasks associated with your investments. Unless you manage your investments entirely by yourself, you will encounter these fees during your investment journey.
How can you minimise investment costs?
Fees are unfortunately an essential part of the investment system, however there are ways that you can keep the expense down.
• Consider using companies or individuals that don’t charge commission. Small businesses or new companies are more likely to waive their commission charges to get business. Be mindful that the fees haven’t been hidden elsewhere by checking the fee schedule.
• Use automated investment platforms to help cut costs. Instead of real advisors, robot advisors use algorithms to provide advice and support without charging you for the service.
• Limit how often you move your money around. Each time you move your money, fees and charges will apply so only do so when the financial benefit is worth it.
Which types of investments charge the lowest fees?
Broad index ETFs and mutual funds typically charge the lowest fees because they are considered one of the simplest types of investment. Any fee that is under 0.2% is generally considered a low fee in investment, whilst anything over 1% is high. Like any other operating expenses incurred, don’t immediately choose the investment that appears to have the lowest fees without checking for hidden costs.
Reasons to invest your money
Grow your money: most investment opportunities such as stocks in the stock market and bonds will allow you to build your money over time, strengthening your financial situation.
Save for retirement: putting your retirement savings into an investment portfolio could mean that you can live off the funds earned from these investments if done wisely. This will take the pressure off saving for your retirement in the future and ensure you have enough money to live a comfortable life.
Achieve financial goals: investing can help you reach your financial goals sooner than saving. Return on investments can be used to buy a house, a car, or even to pay for your children’s education.
Beat inflation: leaving money in your savings account will cause inflation to eat away at the true value of your money. However, by investing in a mixture of assets you can beat inflation by investing your money in areas that are doing well.
Never ignore investment costs as they can end up costing you much more than you expected. It’s worth shopping around for the most competitive rates before investing in an asset class or company. At the very least, make sure you’re aware of all the costs included with the investment.
Navigating the world of finance can be a minefield, but it doesn’t have to be. Our personal finance blog contains all the resources you need to gain control of your finances, from saving and investing to making money.