Tax versus Fees: What Eats Up Your Investment?

Mar 07, 2016

Tax versus Fees, why the question?

Let’s rewind to the 1860s, John Wanamaker, a Philadelphia retailer figured his customers and salesmen had better things to do than spend hours and hours bargaining. His invention was a solution which involved assigning one price, plainly marked, to every product in his store. There’s some question as to who ‘invented’ the price tag, but the story of John Wanamaker often gets the credit.

The price tag caught on nearly everywhere, with one major exception - financial services. Prospective investors still have a surprisingly difficult time figuring out what they'll pay for financial advice and fees around investments that involve costs such as tax, service and brokerage. The markets are unpredictable and costs are forever hiding around corners. Fortunately, we’ve got many resources to our disposal to help us predict, to a certain extent, what the financial markets will do in the future. By utilising financial online resources like Fincheck, Investopedia, Moneyweb, Fin24, etc.we can get a good estimate of the costs involved. The lower your costs, the greater your share of an investment's return. You can't control the markets, but you can control the bite of fees and taxes.

To shed a little more light on the matter, we’ll look at the basic Tax versus Fees involved in an investment:

Fees

Minimizing the cost is a vital part of every investor's toolkit. This is because in investing, there is no reason to believe that you get more if you pay more, and assumptions like these can be costly. Instead, every Rand paid for management fees or trading commissions is simply a Rand lost in earning potential. The key point is that, unlike the markets, costs are largely controllable. Don’t let costs deter you from investing. In recent times investment costs and product fees have come under the public eye. There has been a shift towards investment products that have more transparency and are easier to understand. Fees have generally reduced over the years as technology and information systems have improved. This has been good news for the average investor, although all the changes and new choices can be quite confusing.

A recent development in the unit trust industry has been the use of the ‘Total Expense Ratio’. TERs are now published with investment performance figures in fund fact sheets distributed by the asset management companies. The TER is a measure of the unit trust fund’s assets that were spent as operating costs. It is measured as a percentage of the daily average value of the fund, calculated over a period of time. Operating costs would include asset management fees, administration costs, custody fees, trustee fees, audit fees and bank charges. A ‘fund of funds’ is a good example of a unit trust fund that would probably have a relatively high TER, but may provide the investor with reduced risk through diversifying into a number of underlying investment funds. The TER serves as a good indicator of overall costs.

Taxes

Nobody likes the thought of paying tax to uncle SARS. But - we do the filling and make the contributions, after all, tax is compulsory. Trying to hide or outrun them never really ends well for anyone. The most obvious tax you’ll be confronted with in your investments is Capital Gains tax. This tax is specifically based on what you made off of your investments. If you bought a stock for R80 and sold it for R100, the government will tax you on the R20 you made. The best thing you can do to minimise your tax burden is to look for tax efficiency. Simply put, tax efficiency is a measure of how much of an investment's return is left over after taxes are paid. Rule of thumb, the more an investment relies on investment income, rather than a change in its price, to generate a return, the less tax-efficient it is to the investor.

The key takeaway

Investors cannot control the markets, but they can often control what they pay to invest. You can’t avoid the taxes versus fees battle, but you can choose your investments wisely, and that can make an enormous difference over time. The lower your costs, the greater your share of an investment's return, and the greater the potential impact of compounding. Do your part to look for a good financial planner, one that understands your needs and what you want from your investment.

If you’d like to read more in-depth articles on investing, there are great resources out there such as Moneyweb and Investopedia, to name a few. Fincheck trusts that this will help you to further understand the world of investing!

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