Understanding Investment Expenses
Investing requires several expenses which include more than just your financial advisor’s fee and have to be borne by the investor. It is advised to be aware of the kind of expenses you have to meet before signing up for an investment. The various fees and commissions might be a bit difficult to discern at first, but once you understand the basics of how to tackle investment-related expenses, it becomes easier to gauge your investment’s net performance.
In this article, we will explore the kind of investment expenses you are likely to run into while you’re investing your money, so you are well informed and prepared when making your investment decisions.
The Importance of Understanding Hidden Costs
The three major reasons why you need to know about all the expenses involved in investing are:
- These expenses can eat into your investment
- They affect the return on your portfolio
- To compare the costs and get yourself a fair deal
How Do I Find out About my Investment Expenses?
The best way to get information about any investments expenses, hidden or not, is to ask your financial advisor. However, it is also advised to do your own research and be prepared with the questions and their follow-ups. Ensure that you ask your financial advisor for documents or terms and conditions outlining the details of your expenses. To avoid these expenses from eating into your expenses, ensure you receive transparency in the transaction.
Here is a list of five questions you should ask your potential advisor or yourself when you’re contemplating an investment:
- Is this a one-time expense?
- What is the expense in the first year of investment?
- What are the subsequent years’ expenses?
- Who will be the recipient of the expense amount?
- What kind of services will you avail of for the cost mentioned?
The answers to these questions will throw some light on what kind of expenses you would be paying if you do sign up for the particular service provider.
What are the Different Types of Investment Expenses?
There is a wide variety of expenses you can incur on your investments. These may seem quite confusing at first, and the several types can be quite daunting to wrap your head around. But this is only until you get past the basic step of being introduced to those expenses. Once you look beyond the “technical” nature of these terms, they are quite simple to get a hang of. The deductions you will be billed on can appear under different names. Here’s a list to help you distinguish the various costs:
- Planning fees
- Investment advisory fees
- Money management fees
- Custodian fees
- Commission
- Marketing fees
- Transaction charges
- Insurance fees
- Administrative fees
- Penalties for early withdrawal
- Any other expense that is deducted or can be deducted from your account
Now we will go through a quick and short description of some of the common investment expenses:
Brokerage Fee: This is charged by the broker who holds your investment account. This fee includes the annual fees to maintain the account, subscriptions to paid investment guides, fees meant for trading platforms. You may even be charged an inactivity fee for irregular trading.
Trade Commission: This fee is so also known as the stock trading fee. This is what you end up paying when you buy or sell stocks. You may also have to pay this fee on other investment options or exchange-traded funds.
Expense Ratio: An expense ratio refers to the annual fees levied by mutual funds, index funds, and exchange-traded funds. This is calculated on a percentage basis of your investment.
Sales Load: Some mutual funds have these additional fees required to be paid by the investor. The payment is made to the broker or the salesperson.
Management Fee: The management or advisory fee is generally paid to the financial advisor as a percentage of the assets under management.
401(k) Fee: The 401(k) is an administrative fee paid to maintain the investment plan. Mostly, the plan is given to the potential investor by the employer.
Keeping in mind the various categories any expense falls under, you can track exactly where your money will go. That way you can eliminate any needless expenditure or base your choice of advisor or broker on their transparency of transactions.
Steer Clear of These Commonly Heard Cover-ups
You might have heard these statements a hundred times. Sometimes, hearing similar statements over and over again, from different people could make them seem like facts. This is where you need to practice caution. We’ve put together a list of such commonly heard cover-ups:
An advisor saying “I don’t have access to expense data”. This is not true. An advisor is always supposed to have access to that kind of information.
What you should do: Look for a more professional and experienced advisor who does not make use of such manipulative and deceptive tactics to sign you up.
An advisor saying, “This will not cost you anything”. An advisor saying that is a huge red flag and you should be on your guard. It is not possible to get experienced, professional, reliable advice for free.
What you should do: Ask for complete information, ask questions about commissions that will be charged and any other commissions the advisor would be making on recommending your particular investments.
These would include:
Front-end load commissions which is the amount of money that is deducted from your assets to pay a commission to your advisor. Back-end load refers to the incentive paid by a product company to the advisor. Companies charge high fees and penalties for early withdrawals to recover the amount to be paid to your advisor as commission.
Level loads is a recurring commission deducted from your asserts monthly.
An advisor saying “I don’t charge for transactions”. In such a case, the expense may be replaced with fixed fees. However, the fee is still tied to transactions – the purchase and sale of investments.
What you should do: Again ask, and make sure your advisor discloses every detail of the information.
An advisor saying, “My services are free”. This is another red flag. Sometimes the salespeople don’t want to bill you directly and instead would prefer to bill your account so they collect the fees directly from you.
What you should do: Ask your advisor why the services are free. Check if this expense will be booked under any other head. Ensure that you go through every detail in writing.
An advisor saying, “Penalties don’t matter because it’s a long-term saving”. Do not fall into this trap. Penalties matter greatly. You might want to cash out of your investment before its term due to various reasons. Under such circumstances, penalties will significantly eat into your returns, and if the investment has resulted in a loss, a penalty over and absolve the loss is another major expense to take care of.
What you should do: Transparency is key. Ask about every product your advisor recommends to you. Question your advisor about what if you want to liquidate the investment before the due period, check his response – and ask for the terms and conditions in writing.
Penalties for Withdrawal
Your advisor has the moral responsibility of disclosing any penalties that you may have to pay if you do decide to liquidate your investment before the due period. The penalty period most frequently is 7 and 7 – if you sell the investment in the first year – you pay a 7 percent penalty. If you sell it in the second year, you pay a 6 percent penalty, and so on until the penalty levying period meets its term.
Here you need to practice caution as penalties can be masked under several other terms such as contingent deferred sales charges, the penalty for early withdrawal, and surrender charges. They all mean the same – that a company can withdraw the amount from your account without needing any additional approval from you for this particular action.
Tax-Deferred Accounts
Do ask for a complete disclosure for the expenses deducted from plans from tax-deferred accounts such as pensions, IRAs, or annuities. This way you can maximize your savings, and defer taxes until you claim the income.
Annuities
Annuities are financial products that pay out a fixed payment to the investor. They are primarily used as an income for the retired. Annuities offer a guaranteed income because of the steady cash flow it promises. If your advisor recommends that you purchase an annuity, make sure that you ask for the following information:
Management fees
Advisory fees
Marketing fees
Mortality fees
Administrative fees
Transaction charges
Termination fees
Maintenance fees
Custodial fees
Any other fee that will be charged because of the annuity
Getting a basic idea of what the actual return would be on your investment will help you plan better. There is no point in losing money over costs which can be easily reduced or eliminated.
Conclusion
Investing in a product can be quite a process. It takes time and effort and a lot of trust to get your money into the right financial products. As such, you should make it a practice to ask a lot of questions – ask your financial advisor valid questions related to the product being recommended. Do not hesitate to inquire about the likely expenses, as this will allow you to get rid of expenses that you don’t need to bear. It is advised to always approach a professional and experienced financial advisor and request for a complete disclosure of all the costs, big or small, involved. Transparency of operations is the key. Remember that it’s better to be wary before you put in the money while your options are still open.
If you are looking to begin investing, get started by using Paladin Registry’s free match service to find a suitable financial advisor for your investing needs.
To learn more about the author William Hayslett view his short bio.
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