Any kind of investment involves cost and taxes. These expenses can bring down the returns on investment. It is, therefore, important to know these costs and reduce them wherever possible. This will help maximise the returns.
A few years back financial advisors would lure investors into buying Unit Linked Insurance Plans (ULIP) on the pretext of life cover and market related returns. However, the product was completely mis-sold and investors actually ended up paying huge amounts as front end load.
The same was the case with New Fund Offerings (NFOs) from Mutual Fund houses. Investors subscribed to the NFOs in the belief that they were cheaper. However, they ended up paying entry load of 4 to 5 per cent.
Due to rising costs and inflation, expenses on investments are increasing year-on-year. Today, there are fees charged for maintaining accounts like savings account or demat account, buying and selling shares, MFs or insurance products and so on. These costs can add up to significant amounts and eat into the gains from the investments. Over a period of time, it can have a compounding effect and bring down the wealth.
At the same time, market innovation, technology changes and increased competition provides many new and useful mechanisms for investors to manage investments in a cost effective manner.
Let us look at some of the expenses incurred on investment products and how we can reduce them:
Brokerage: Whenever we buy or sell shares on the exchange, we are required to pay brokerage which can range from 0.20 per cent to 0.50 per cent of the transaction amount for delivery based transactions. For those trading in shares, this brokerage can become a significant cost. Investors should look at brokerage houses which charge low brokerage, but offer quality service. There are many online trading portals which offer seamless service at low cost. Investors can always look at such broking houses.
Depository participant charges (DP Charges): A person trading in shares has to open a beneficiary account (demat account) with a Depository Participant. The DP at times may be with your broker itself.
The DP charges annual maintenance charges (AMC), which may range from Rs 300 to Rs 750 plus service tax. The DP also charges for transactions, which may vary between Rs 10 and Rs 35 per transaction.
So, investors must look at not only the charges, but also convenience in transacting. In case of a default in transaction, your stock may be sold in auction and the liability of meeting the gap in the price, if any, is with the account holder. So, there could be monetary loss.
Bank charges: With banks offering a number of services, they also levy charges for most of the services. These could be fees for signature verification, issuing cheque books, cancelling cheques, debit cards and so on. The fees vary from bank-to-bank. One way of reducing these charges is doing more online transactions and reducing the use of cheques.
Mutual fund entry and exit load: Knowing the fund charges and load while investing in mutual funds is important as they can play a decisive role in the returns generated especially in the short term. Fund charges can be approximately 2 to 2.50 per cent of the investment value annually. The fund charges and loads have to be in line with SEBI regulations. Charges such as entry and exit loads are mentioned in the offer document.
ULIP: While subscribing to ULIPs, it is important to know the front end load for the same. The insurance company charges not only initial charges, but a recurring expense is also charged to the plan. The charges can bring down the value of your ULIP significantly over a period of time. ULIP charges can be approximately 2 to 3 per cent of the investment value annually. The charges have to be in line with IRDA regulations.
Insurance: Always buy term insurance online as the premiums are lower. Most life insurance companies offer this service.
Freeing up loans: If you have an option, free up your loans to the maximum possible extent. If the returns from your investments are lower than what you are paying for your loan, it is better to repay your loan instead of paying higher interest.
Credit cards: You can use a credit card where there is no surcharge for using it. By doing so you can enjoy interest free credit period. You will also not lose out on interest that you may have lost, in case you had to withdraw funds prematurely or sell alternate invests such as equities. However, here it is important to make the payment to the card issuer on time, or else you will be charged interest.
Taxes: The most and biggest impact is taxes. It is important to know the tax incidence of a particular investment when exiting or redeeming. At present the country has lower short term capital gain and nil long term gain for stocks traded on the stock exchange. High taxes can significantly reduce the returns from your investment.
For example, if you place an amount of Rs 1,00,000 in a bank Fixed Deposit for one year at 9 per cent. The returns you get post tax will be approximately Rs 6,300 (that is approximately 6.3 per cent) in case you fall in the 30 per cent tax bracket. Thus, the balance amount of Rs 2,700 is tax expense.
By investing in tax efficient instruments, you can reduce the tax incidence (such as investing in tax free bonds, equity oriented mutual funds, and so on)
As an investor, you must control known and hidden investment costs and taxation to ensure that you obtain maximum net returns from your investment assets.
A prudent investor will not only look at the potential returns, but also the expenditure involved in investing.
The writer is a freelancer