5 Concealed Costs That Destroy Your Investment Returns

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Up to this point, I’ve basically been telling you all of the amazing ways that saving and investing your money can MAKE you money in the long run. Like in my articles How to Invest in Stocks with Only $20 for an Amazing Future and 5 Places to Set and Forget Your Money to Let It Grow.

Well, today I’m going to do just the opposite. I’m going to talk about all the ways that investing (carelessly, that is) can actually LOSE you money.

Before you freak out, I don’t mean put you in debt or anything. I just mean that if you’re not careful, losing a few dollars to these things today could mean losing the potential for thousands of dollars in the future.

Remember that old saying “a penny saved is a penny earned”? That’s basically what I mean here. Every dollar invested today is worth $2 in just a few years. Making sure that you understand these common fees and staying aware of them will make all the difference in the world.

Don’t get me wrong, you’ll still save up plenty of money if you just follow the guidance I’ve given you so far. But a recurring fee of just a couple dollars with each trade, over a lifetime could easily end up costing you $100,000 in potential growth lost. Are you convinced now?

Uhh yeah!!

Good!!

So what are these pitfalls and tripwires that I need to look out for??

Well, I’m glad you asked!!

 

Trading Fees

 

For you Robinhood users, this may seem like a foreign concept to you, but there are actually brokers out there that will charge you for each trade that you make.

Nowadays it’s typically a flat fee if you’re using an online discount brokerage, so no matter how many shares you’re buying, you’ll have to pay the exact same amount.

There are also “full-service” brokers who offer a HUGE variety of services like research, tax tips, retirement planning, and even just general investment advice. These brokers are pretty comforting for first-time investors who need a little hand-holding and can keep you from making some rookie mistakes. Unfortunately, they’re able to offer these services by charging much higher commissions than the discount brokerages that we tend to preach about in our articles.

Honestly, for those of you looking to see the most gains from your money in the long run, stay away from full-service brokers. Hopefully, between my articles and other research, you’ll learn everything you need to know to be confident in your investment strategies. That’s my goal after all. To help more people like you make the most out of their money!

So back to the topic at hand. Are these fees a bad thing? Weeeeeell it depends. Typically the more money the broker makes, the more services they can offer you. So it really depends on what’s important to your investing strategy.

Someone who is just investing in ETFs may not need the full research suite of TD Ameritrade and wouldn’t want to pay the $6.95 per trade. On the other hand, someone who invests in individual stocks might find the fee well worth their money.

I don’t want to seem like I’m trying to steer you away from more expensive brokers. They definitely have more to offer, and there can be advantages in some cases. But for the style of investing that I’m preaching and for those of you that aren’t looking to become day traders, fewer bells and whistles usually won’t hurt.

The main point here is just to be aware of how your broker is making money off of you. If they aren’t taking too much of your money or what they offer is worth your money, then you can stop worrying about trade fees.

 

Expense Ratio

 

I’ve talked a bit about this before in my article How to Divide Up Your Investment Portfolio, so if you’ve read that article already then this may sound familiar. If not, I suggest you check it out if you’d like to know more about how to divide up your portfolio over different asset classes and market sectors.

Anyway, the expense ratio of a fund is how much of the money they make is being used to actually run the fund. This includes everything from office space to paying the employees. And if you haven’t guessed already, the larger this number is, the smaller your dividend returns will be. This matters a lot in the long run of your investments since these dividends play a large part in the compounding effect of your investment growth. I will talk about this in more detail in later articles but just know for now that high dividends are never a bad thing.

So because these expenses can cut into your returns, you’ll want to invest in funds that have the lowest expense ratio possible. Some of you may be worried about the quality of the fund declining with lower expense ratios.

I mean, how can they pay for the best people if they don’t give them enough money?? Which makes me feel kinda like Mr. T because I PITY THE FOOL WHO INVESTS IN INDEX FUNDS WITH A HIGH EXPENSE RATIO!!!

But in all seriousness, this is a valid concern if you’re investing in a managed fund instead of an index fund. However, YOU SHOULD NOT BE DOING THIS! I’ll explain more about this in another article, but in short, it’s better to capture the total gain of the stock market than just portions of it 99% of the time.

This is so true that there’s even a book about this called The Little Book of Common Sense Investing where John Bogle talks almost exclusively about this fact. I’m actually reading this book now, and I definitely recommend it if you have the time.

Bottom line: invest in index funds (mutual funds or ETFs) with the lowest expense ratio possible.

 

Commission Fees

 

Now if you’ve been reading my other articles, then you’ve probably heard me talk a lot (maybe even too much for your taste) about ETFs. And as much as I love them, there are a few that try to “swindle” you out of your future returns so to speak. They’re really just trying to make more money, and they do this through commission fees.

So what are these mysterious commission fees?? Well, a commission fee on an ETF is a fee taken out of the money you invest in the fund. This is actually separate from the trading fees discussed earlier, so if you’re not careful, you’ll be paying two fees which can add up to THOUSANDS of lost dollars over the years.

This is one of the costs that can really sneak up on you since it isn’t as obvious as regular trading fees. Not to mention the fact that they are applied on buys as well as sells.

Luckily, there are many ETFs that are commission-free, and some brokers even allow commission-free trading of all ETFs (of the ones they offer anyway).

I recommend doing some research into your brokerage to figure out which commission-free ETFs are offered. If they are good options, then try to invest mainly in these to cut down on unnecessary costs.

 

Bid-Ask Spread

 

This one is a bit more technical, but have no fear! Captain Pretty-Good-Explainer is here!!

Anyway, the bid-ask spread of a stock or ETF is the difference between what people are wanting to buy it for and what people are wanting to sell it for. Pretty simple, right? So how can this cost you money?

Let’s imagine a stock whose bid price and ask price are spread further than a hookers legs on a working Friday night (okay maybe not that far). Now let’s imagine that you made the mistake of buying the stock at the full ask price (what people are trying to sell it for) because you just kneeeeew the stock was going to go up.

Assuming that you’re not a HORRIBLE trader (or that you got lucky) and the stock actually did go up, when you went to sell it, you’d likely have to sell it at a lower price than what you’d actually want to sell it at because of the large spread. And if you’re desperate enough for whatever reason, you may even sell it at the bid price (what people want to pay for it).

Despite how much the stock’s assessed value may have increased, you didn’t actually see this full growth because you bought for more money than you should’ve and sold for less money than you could’ve.

I think you can see why this would be a bad thing. The best way to avoid this predicament is to either avoid stocks and ETFs with large bid-ask spreads or to be aware of the large spread and keep it from getting the better of you (by not selling frequently).

It’s all in how much risk you can stomach, really. In the end, most of the good index funds that are out there should have negligible spreads, so if this is your strategy, then you won’t have to worry too much. Just keep it in mind.

 

Taxes

 

Now is the point in the article where it’d be very easy to insert Ben Franklin’s quote about death and taxes. But honestly, the quote itself is about as unavoidable as the two things it mentions, so I’d be surprised if you haven’t heard it enough already.

Sadly, investing is no exception. If you’re wondering what you have to pay taxes on, the answer is the same as it is for every other part of life: Everything. Seriously though, you pay taxes on dividends, interest, and the infamous capital gains (yes, unfortunately, that weird tax all those old people gripe about will now start to affect you too).

The percentage you have to pay varies based on several things including your tax bracket, how long you’ve held the stock, and whether the company pays the U.S. government taxes before paying out their dividends (Don’t worry. All American companies do this).

I know I’m kind of brushing over all of this, but there are quite a few specificities to all of these different taxes. So it’s going to be something I have to cover in another article down the road. But there is one more thing I’d like to mention about taxes.

If you sell for a loss, this essentially counteracts your capital gains. Meaning that if you sell a few shares of one company for a $2000 gain and sell a few more of another for a $2000 loss, then you won’t have to pay any taxes! Of course, this also means that you didn’t make any money, so maybe don’t do that.

But if you’re looking to get rid of your position in a company or fund anyway, you might as well take the loss because:

1. It’s better to cut your losses early
2. You can use that loss to offset your gains

And if you’re feeling particularly crafty, you can strategically sell for a loss to offset a large gain. Just make sure you don’t buy the stock back within 30 days or it’ll qualify as a wash sale, and you won’t actually get a tax break from it. But I’m not a fan of this personally. As you’ll come to see, I prefer to avoid the capital gains tax by holding for as long as possible and selling very rarely (if ever).

Look I know I kind of brushed over some of this stuff pretty quickly (especially the tax stuff), but try to keep yourself from panicking just yet. Like I mentioned before, there’s A LOT of twists and turns to these various aspects of investing, but I promise you I will help you navigate them!

I love learning more and more about these things, and I love to share it with all of you. So stay tuned for upcoming articles as I get into some more specifics of all of the things I mentioned here.

I hope I was able to give you a basic understanding of the things I talked about here today. If not, feel free to go to the Contact page, and send me a personalized message about how I totally suck.

Thanks for reading and stay busy Living Better!

Until the next one,

Noah

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