How to Manage Your Fees and Taxes When Investing
Whenever one thinks of what makes a successful investor, the typical benchmark is a sustainable, high-yielding investment portfolio that allows said investor few worries in life. While not all investors will be able to retire in 10 years after starting their journey, the ultimate goal is putting your money to work, beating inflation and at the very least not losing a budgetary step or two after retirement finally comes.
While making the right investment choices will do most of the heavy lifting, there are other means to increase your overall portfolio profitability. Means that usually stay under the radar as the less ‘cool’ part of investing. And that’s managing your investment fees and taxes.
Why is this important
When times are good and portfolio returns run high, you will rarely notice minor expenses that chip away at your portfolio. However, over time these expenses mount up to significant sums that you’d do well to try and reduce. Of course, with annual returns in the teens or even higher will make a .5% investment fee pale in comparison. But, if you consider the volatility factor in any investment, you’ll understand that there will be years with diminished returns. During those years, any expenses that you’ve failed to reduce will feel especially painful.
The same goes for taxes on your investments. While your investments usually do not incur any payments unless you cash out, you could still face taxes if you receive dividends. And, once you do cash out your gains, capital gains tax will eat away at those, too. So, it is very important to plan and structure your investments in a way that helps you reduce expenses on both fees and taxes over the investment period.
How to deal with investment fees
There is little to no way you can avoid investment fees altogether. But, you can reduce them greatly if you’re not afraid of doing a bit of research beforehand. Here’s how you approach the fee issue:
Try and look for the cheapest option that still matches your needs and expectations. If you’re just starting on your investing journey, or you wish to optimize your pre-existing investments, do your own research. Investment brokerages and actively managed funds are bound to disclose their fees upfront. Therefore, if you’re looking for someone to take care of your investments, look for lower transaction and annual fees. Other fees you should keep in mind are deposit, withdrawal, inactivity, advisory and research fees. You can reduce or eliminate these by limiting deposits and withdrawals. Inactivity fees will require you to log on to your account regularly, but may also require you to make a transaction. Advisory and research fees refer to ‘paid content’ that you don’t need to use – especially if you’re willing to put in your own time.
While scrutinizing your investments, portfolio managers and other investment-related costs, stay aware of fees related to your bank, for example. If your bank charges a fee for outgoing payments and then your investment account takes a fee for incoming payments on top of that – that’s just no good at all.
Switch up (or rather – down) your investment tactics. For example, don’t exaggerate with your transaction count, or in other words – slow down there, tiger! If your account manager takes transaction fees, you can rack up unnecessary bills that will eat away at any additional gains you might’ve made. In a way, this means taking a more passive approach and settling in for the long term, rather than trying to time the market and gunning for immediate riches.
Tax evasion is illegal, however…
Optimizing your investment tactics and strategies can help you save on tax payments it’s perfectly legal to avoid. Here are some examples of how you can change your investment approach in order to increase your net returns over time.
Know your tax bracket and tax allowances. This information can help you in determining how many taxes you’ll be due at the end of the tax year. There are significant differences in tax allowances that directly correspond with your tax bracket. For instance, in the UK anyone who falls in the basic rate bracket has a personal savings allowance of £1,000, £500 for the higher rate bracket and £0 for the additional rate bracket. And, if you earn up to £17,570 a year in 2022-23, you’re eligible for a £5,000 starting rate for your savings and investments (as long as your personal allowance doesn’t exceed £12,570), meaning you will not have to pay any tax on returns of up to £5,000. That’s a grand total of £6,000 tax-free money!
Similarly, as with reducing investment fees, you can reduce the total tax amount due at the end of the tax year, if you take a more passive approach to investing. For example, don’t buy and sell your assets frequently – any capital gain can incur a tax payment. You’ll still have to pay taxes once you do sell the assets down the road, but limiting and planning for these transactions can help you plan for a tax-efficient transaction. Like selling a failing asset in the same year as the profitable asset to offset gains. So taking a more long-term approach can help with your investment returns overall.
If you’re from the UK – invest in an ISA. Individual Savings Accounts have a £20,000 tax-free allowance that everyone is eligible to. On top of that, you can get additional tax relief of up to 30% if you invest into UK businesses.
In the US, 401(k)s and Roth IRA’s do allow for certain tax ‘enhancements’, which can be beneficial. For instance, since Roth IRA contributions are already after-tax money, you don’t pay any tax on contributions and withdrawals. What’s even better – your interest is also tax-free.
The takeaway
Whether you’re a novice or have been investing for a while, there are always ways you can increase the yield of your investment portfolio. All you need is some research and a basic understanding of your home country’s tax laws. If that’s too much a task for you, it’s always possible to hire an advisor to help you. A one-time payment is still ways better than losing your investment returns over an extended period of time.