The Sneaky Ways Investing Can Actually Cost You Money
My obsession with saving money began fairly recently. Believe it or not, I was not always as money-savvy as I currently try to be. I began saving VERY small amounts of money when I graduated university and landed my first full-time, salaried position. I was around 23 years old at the time and, like many young adults around that age, the last thing on my mind was retirement or other savings. My priorities were weekend trips and partying with my friends, eating out for almost every meal, and making every effort to make my rental payments on time, in full. Saving for my future ranked pretty far down the Importance List.
A couple years down the road, as my salary grew and my maturity level slowly rose, I discovered my love for personal finance. The more articles I read, the more I knew I had to immediately start investing my money for retirement. Savings became my top priority, and I developed a strategy to achieve my savings goals which you can read about here. The problem was that I had limited understanding of investing (outside of the few articles that I had read for enjoyment).
I started putting money away in my tax-free savings account. In Canada, you can open a tax-free savings account through your bank by filling out an application online, over the phone or in person. The money you put into a tax-free savings account does not give you a deduction on your taxes, like RRSP contributions do, but you do not have to pay taxes on any of the income you earn in your account. Not surprisingly, there is a limit on the amount you can invest in a tax-free savings account. The total you can contribute to your tax-free savings account, as of 2016, is $46,500.00. You have the ability to investment in various items, such as regular savings accounts or mutual funds.
Mutual funds are a group of investments in various stocks, bonds, and other funds that numerous people invest their money in. The mutual fund is managed by a fund manager who decides which items to invest in and thereby make the most money for the investors. Mutual funds come with varying levels of risk, depending on the type of fund; the investor chooses the amount of risk and potential return they would like to receive (in general, the rule of thumb is: the higher the risk-level, the higher the potential return). Mutual funds can be purchased as part of a tax-free savings account, as part of a regular investment portfolio, or as part of registered retirement savings and can be acquired through your bank, your financial advisor, or other investment account.
I decided to put my savings into mutual funds. I was so excited to finally have money invested in something other than regular savings accounts that I checked the value of my investments almost every day. My investments were increasing in value at a much quicker pace than my savings accounts ever did, and I was thrilled! Thrilled, that is, until I read an article about investment fees. I was oblivious to the fact that I was paying fees on my mutual funds because they did not charge me a fee when I invested the money.
When I started researching the full variety of investment fees, I very quickly became overwhelmed. There were so many types of hidden fees I could be getting charged, and these fees could seriously affect my long term investments. It took me a while to understand all of the different fees, how they impacted my investments, and an acceptable fee amount for each type. Because I realized, during my research, that there’s a serious lack of easy-to-understand information, I want to give a brief explanation of each of the types of fees you may be paying on your investments, and approximately how much you may be getting charged without ever knowing!
Why should you care? Fees have a massive impact how much you earn on your investments, over time.
The vast majority of investments come with fees and costs. The first step to managing fee amounts is learning what they are and understanding when (and how) each of the fees will be incurred.
1. Account fees: Account fees are usually charged annually on investment accounts. For example, opening and maintaining an RRSP account at my bank costs $100.00 per year. This is a flat fee, not based on the amount of money you have invested, or the amount of stocks you buy and sell during the year.
2. Transaction fees: Transaction or trading fees are charged every time you buy or sell; normally, your bank or broker establishes a set amount for all your transaction fees. This fee can range from $0 – $50 per trade; it will be charged on top of the amount you are actually investing. You can often find deals when opening up new accounts that will give you a set amount of charge-free trades, based on the amount you will be investing (more money invested = more free trades). I opened up a registered retirement investment savings account through my bank during a “young investors” promotion that gives me four free trades per year until I turn 36!
3. Investment management fees: These fees are paid to your financial advisor; they are often based on a percentage of the total amount of money in your portfolio. This fee will be charged annually, quarterly, or monthly. It will be deducted from the cash account in your portfolio. If there is no cash sitting in your cash account, your investor may sell and withdraw a portion of your investments to cover this fee. These fees can range from 0.2%-2% or higher, and can add up to thousands of dollars per year. The only upside is these fees may be deductible on your tax return.
4. Expense ratio fees: Expense ratio fees are the fees charged to manage the mutual funds you invest in. The fee is not taken directly out of the money you invest; it’s deducted from the returns you earn throughout the year. Expense ratios can range from 0.0% – 3% and can have a significant effect on long-term investment returns. The highest expense ratio fee I currently pay is 0.5%, which is a much lower rate than the one attached to my original mutual funds account (they charged 2.60% annually!). Since this fee is taken from your earnings, you may not even be aware it is being charged.
5. Front-end and rear-end load fees: These fees are either charged when you buy (front-end) or when you sell (rear-end). They are normally charged as a percentage of the stock purchase price, and they’re deducted from the value of your investment. For example, if you purchase 1 share of a company worth $1.00 with a front-end load fee of 5%, your investment will actually only be worth $0.95. Note: Front-end and rear-end fees are added on top of any expense ratio or other fees you might be charged.
If you made it through reading about all of the above fees, I congratulate you! I’m sure this isn’t the most entertaining article you’ve ever read.
I know the list above doesn’t give you a concrete To-Do list; I just want to plant an Sparknotes-type seed for learning about what investment fund fees are so that you can have detailed discussions with your mutual fund manager and thereby avoid, reduce, and manage fees where possible. And, although fees can be confusing (and frankly, boring) to learn about and understand, they have a huge effect on your overall portfolio and how much money you earn from your investments in the long term. The less money you spend on fees, the more money you will have available for retirement. I don’t know about you, but I want to retire as soon as I possibly can!
Jodi Paradoski is a full-time accountant and coffee addict who loves animals, taxes, spreadsheets and savings accounts. She recently started her own blog, Economical Girl’s Guide!
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