Keeping Costs Low
Benjamin Franklin once said that there are only two things in life that are certain: death and taxes. One of the downsides of earning any income is that you will be required to pay tax. Since you earn income on your investments, you’ll be taxed. And since you’ll also be using investment providers, you’ll need to pay fees for the service. Combined taxes and fees can eat into your overall returns. This lesson shows you how to reduce these costs legally and increase your return on investment.
Tax is unavoidable. However, most countries want to encourage investors to help grow the economy, so here are a few options.
USA: Traditional and Roth IRA
A traditional individual retirement account (IRA) is for anyone in the US under the age of 70-and-a-half. Your contributions are paid gross (tax free), but when you withdraw money in the future, you pay ordinary income tax rates. You are required to take minimum distributions from your account calculated as a percentage of your funds at age 70-and-a-half, whether you need the money or not at that time.
A Roth IRA allows you to save for retirement using your net (after-tax) income. When you withdraw money, you will receive your money tax free. You can only take advantage of the account if you make less than $133,000 as a single investor or $196,000 as a couple. You can contribute a maximum of $5,500 every year until you are 50, at which point, you can contribute $6,500 every year. The requirements change, so check these every tax year.
UK: Individual Savings Account (ISA)
Every person in the UK over the age of 16 is able to invest £20,000 into an individual savings account and earn interest tax free. You are only allowed to open one ISA per year, but you have the option of transferring your money to a new provider. You can either open a new cash ISA (through a bank) or a new stocks and shares ISA (though an investment service). The UK government also recently launched an Innovative Finance ISA, which allows peer-to-peer investors to earn money tax free.
For higher earners paying the highest tax rate, investing using an ISA is a no-brainer.
My recommendation is that before you start investing, you research all relevant tax rules applicable in your country. Believe me, it may influence your decision of what to invest in significantly.
There are several investing fees to be aware of before you invest your money with any service.
• Investment management charges: If you use an active fund, you will be charged a fee to pay the fund manager.
• Administration charges: This is a fee to pay for the setup of your account.
• Platform fee: The platform you use may charge a fee annually to access their research, articles, and to track your investments if you open a product with them.
• Exit fees: This is the charge associated with leaving a platform.
• Fund trading costs: Each time you buy an investment, you may be charged a trading cost, sometimes referred to as a brokerage fee.
Fees are expressed as a percentage or a nominal amount. If you’re investing a small amount (less than $100,000), you may want to consider a service that charges you a percentage of your capital, as this will often be more competitive than the flat fee. If you’re investing six figures or more, consider the flat fee.
To find the most competitive provider, you can use online comparison tools, such as Compare Fund Platforms, or google, “most competitive investment providers [your country].”
As you may have realized, the problem with investing (or trading) too often is that you will pay a lot of fees for entering and exiting that investment. Most of us are encouraged to buy and hold investments, not only to weather short-term volatility in the market but also to make sure any gains we do make are not eaten up by fees from over-trading. If you’re tempted to invest in individual stocks or ETFs more often than monthly, you’ll want to find a platform that has lower trading charges.
In summary, the less money you pay in fees and taxes, the more of your investment, plus gains, you’ll get to keep. Tomorrow, we’ll look at how much to invest.
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