When calculating the yield of an investment, people generally focus on the returns. There is nothing inherently wrong with this. However, they sometimes fail to factor in the various investment costs, which reduce the net returns, sometimes so drastically that their capital does not grow in any meaningful way.
For this reason, today we explore a few ways in which you can reduce the cost of investing so that you achieve your investment goals.
- Understand the fees charged on your investment – A fund manager will charge you a small percentage of your capital for overseeing and hopefully growing your investment. This is usually stated upfront. However, there may be other fees charged, which lower your overall capital.
Before committing to any investment, find out under what conditions you may be charged and how much. Having done so, decide if it still makes financial sense. Some examples of extra fees include transaction fees, performance fees, custodian fees and surrender charges.
- Know when to buy and when to hold – When you trade individual stocks and bonds, you incur a custodian and transaction fee, which eats into your capital and by extension, into whatever profits you make when trading. Transacting less frequently reduces these fees. It is advisable to make less frequent but larger transactions instead of many smaller ones. For example, it makes more financial sense to conduct two trades of Kshs 50,000 each instead of ten Kshs 10,000 transactions. However, you still need to evaluate this cost versus the opportunity cost of missing out on potential gains because of leaving your capital sitting in cash for longer.
- Prefer tax-exempt investments – A lot of the returns you make from an investment may be consumed by taxes. However, as the government tries to entice more Kenyans to invest, it has provided various tax benefits, specifically for those who invest. You can preserve so much more of your capital when you place it in a tax-exempt or tax-deferred investment product. Find out whether the investment you are about to make qualifies you for any tax benefits, and use that to your advantage. Note, however, that many of these exemptions are meant to encourage long term investments and you may be penalized for early withdrawal.
- Consider the return to cost ratio – An important consideration is the interest you are expecting weighed against all the costs. Granted, investments are unpredictable and returns are not always guaranteed, but there is a target rate you have in mind if you are considering a particular product.
Say, for example, you are picking between two products; one which charges 5% management fees but has a target return of 20% and another which charges only 2.5% but offers a 7.5% ROI. While at face value, the second firm charges less, it swallows a larger percentage of your capital than the first for the return it is earning you. It would therefore be less expensive to invest in the first company than the second. Nevertheless, the higher return could mean you are accepting more risk, so always consider your risk appetite before investing in any product.
In conclusion, you have invested to achieve a certain goal – to buy a home, pay for education or even to retire comfortably. Whatever the reason is, you will have much slower progress if the interest you are earning is constantly being reduced by unnecessary costs.
If you implement the above, you will be well on your way to achieving your goals.