What Fees and Taxes of investing to look out for

Fees and taxes of investing

When investing for the long term, fees play an important part in the journey. By important a more correct word to use would be possibly detrimental to long-term gains.

In this article, we will go over 14 different types of fees and taxes of investing that you may come across. Identifying these and avoiding/reducing these fees and taxes will help you get the most gain for your money.

Brokerage fees

When it comes to brokerage fees these are not limited to the just commission when investing/trading stocks. These can be broken down into Trading fees and non-trading fees. Trading fees are charged when you trade (buy and sell), this can be a commission, spread, financing rate, margin rate or conversion fee. With non-trading fees are charged not directly related to trading such as deposit, withdrawal and inactivity fees. We can also find that some brokerages charge a fee, whether it’s a percentage or fixed fee for using the platform.

Commission

The commission is usually based on trade volume or charged as a flat fee per trade.

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When it comes to getting value from such you will have to decide the size of investments you will make as to which type of fee will save you more money. For example, Hargreaves Lansdown charged £11.95 per trade if we compare this to an example of a percentage commission fee of 1%. For example, anything under £1,195 would be more cost-effective using the percentage fee broker, but anything over you will be saving more using the flat fee broker.

We can find that some brokers don’t charge a commission which makes it much easier to invest with lower sums of money and allows an investor to make many smaller trades/investments more regularly.

Though we find that with these zero commission platforms orders are placed differently than commission brokers. 

“The headline is zero commission, but people don’t realise that their custodians could be selling their order flow for money”, says Fidelity spokesman Robert Beauregard.

Platform fee

As well as charging a commission, some brokers charge a platform fee. This is usually charged by what we call full-service brokers and such a fee is to pay for the overhead of the services which they provide.

Not all Brokers charge a fee and when looking/comparing brokers that charge a platform fee you have to evaluate whether you will use the services they offer to make the most of this fee. Remember brokerages are there to serve you as a customer and investor so this is very important to look into.

These platform fees can vary in cost but also they can be fixed fees or percentages. 

For example, Interactive Investor charges £9.99 per month compared to Vanguard which charges 0.15% on the first £250,000.

Depending on portfolio size this fee can dramatically affect your long-term returns.

Fees attached to your money

 

Spread

The spread is the difference between the buy and sells price, otherly known as bid and ask price. All brokers have a spread so if you were to buy and sell the trade at the exact same time, you will generate a loss. For example, if you have a stock with a selling price of £100 and a buy price of £101, if you buy and sell it immediately you would have created a £1 loss.

The spread isn’t the same for all stocks and is something to look at before making a purchase. We normally find with larger companies which have a high volume (amount of shares traded) the spread between the buy and sell price is much smaller than smaller companies which are traded less.

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We find with low liquidity stocks such as those on the Over Counter (OTC) market have much higher spreads than stocks found on the main market.

Margin rate

Trading/investing on margin means you are borrowing money from your broker to trade. To borrow this money they charge you a margin rate because they are lending you extra money. These rates can vary from broker to broker but it’s not advised to invest with margin or any borrowed money.

Conversion fee

A conversion fee can be charged when doing a transaction which requires a currency conversion. This type of fee can occur on a trade or when depositing/withdrawing money.

For example, if you were to buy USD-denominated shares like Apple ticker AAPL while using a GBP broker and GBP cash to buy this share, the broker will first have to convert the GBP to USD, only then can it buy the Apple share in USD. Currency conversion can be spread only for a fee or the broker may charge a commission for the conversion.

Deposit & withdrawal fees

You may find some brokers charge a flat or percentage fee when depositing or withdrawing from the account. These types of fees can vary from broker to broker, some don’t charge such a fee.

Taking Trading212 for example they charge a 0.7% fee when depositing cash via a card, this is to cover the costs of such a transaction. But bank transfers are free to do and so you will have to take into account how you will fund your account.

Inactivity fees

You may find in the small print with some brokers that there is an inactivity fee. This fee is charged to investors who haven’t bought or sold for a specific amount of time which is set by the broker.

Some brokers try to compensate for the lack of commission by charging inactivity fees. 

This is a good fee to look out for as you don’t want to be caught out, especially when you are a buy-and-hold investor.

Performance of investments

Fund fees

Ongoing charge

An ongoing charge otherly known as an expense ratio is a fee which an investor pays when holding a fund, whether that be a fund or an ETF. This fee is charged to cover the costs to manage such a fund and is normally expressed as a percentage.

This fee is typically paid out of the fund’s assets, so you won’t be billed for it, though it will come out of your returns.

There are two problems when it comes to high expense ratios. Firstly with a higher expense ratio a higher portion of your money is going to the management team instead of you. Secondly the more the management team charges, the less likely the fund will match or beat the market’s performance.

An example of an expense ratio is that if a fund returns 8% and has an expense ratio of 1.5%, you only earn 6.5%. If the fund performs poorly and returns are negative, this gets amplified with the addition of the ongoing charge.

Typically an expense ratio under 1% is good. You can find many Tracker ETFs which offer a low expense ratio such as Vanguard FTSE All-World (VWRL) at 0.22% or Vanguard S&P 500 (VUSA) with a 0.07% expense ratio.

Initial charge

An initial charge, sometimes otherly known as an entry charge, is an upfront fee which is charged when you invest money into a fund and is deducted before you invest.

Some funds charge such a fee to cover the costs of setting up the investment, such as administration costs and marketing costs.

Not all funds have such a charge but the percentage can vary.

Performance fee

A performance fee is different and separated from the ongoing charge. The performance fee is charged when the management of the fund hits specific targets. These are set by management. 

One example is if the management of a specific fund set a basis for a 20% outperformance over a benchmark. If the fund performs well and completes this goal then an extra fee will be taken and awarded to the managers.

Withholding tax

Withholding tax if applied by overseas governments on dividends or income which is received by non-residents.

For example, if we invest in a US stock such as Coca-Cola which pays a dividend when the dividend is paid a withholding tax of 30% is applied. Coca-Cola pays a dividend of $0.42, with the 30% withholding this is reduced to $0.29. [46]

*As of May 2021

Lucky the UK government has a double taxation agreement (DTA) in place with many countries, this reduces the amount of tax paid on the dividend or income

Filling out the W-8BEN form reduces the withholding tax on US and Canadian stocks from 30% to 15%.

This now means that instead of receiving a $0.29 dividend we would now receive a dividend of $0.35.

To see the list of potential taxes an investor would have to pay for certain countries you can search on the Gov website: https://www.gov.uk/government/collections/tax-treaties 

SIPP can exclude withholding tax but this comes down to the broker. You may be able to be paid the income at gross. This reclaim can only be done by the SIPP administrator, the administrators generally don’t consider this worthwhile for anything other than US shares.

https://the-international-investor.com/investment-faq/reclaim-withholding-tax-foreign-dividends-isa-sipp 

Taxes clamping your money

Stamp duty

When investing in UK companies, whenever you buy you usually pay a tax or duty of 0.5%. You don’t pay stamp duty when you sell.

When you pay stamp duty:

  • Existing shares in a company
  • An option to buy shares
  • Interest in shares
  • Shares in a foreign company that has a share registered in the UK
  • Rights arising from shares, for example, rights you have when new shares are issued

When you don’t pay stamp duty:

  • Are given shares for nothing
  • Subscribed to a new issue of shares in a company
  • Buy shares in a ‘open-ended investment company (OEIC)
  • Buy units in a unit trust from a fund manager

Capital gains tax and allowance

When you sell your shares/investments for a profit, depending on how much profit, you may have to pay capital gains tax.

You may need to pay capital gains tax if your shares are not inside an ISA, you sell units in a unit trust or sell certain bonds. You don’t have to pay capital gains tax if you sell shares in an employer share incentive plan, sell UK government gilts (including premium bonds), qualifying corporate bonds or employee shareholder shares.

Each year you as an individual are given an allowance, for the tax year 2021 to 2022 it’s £12,300. But this can change, both increasingly or decreasingly. For example the tax year 2019 to 2020 the capital gains allowance was £12,000.

This allowance doesn’t get taken forward each year, so if unused then you will lose it and will reset.

Dividend allowance

On top of a capital gains allowance, we investors also get a dividend allowance. Each year we can earn £2,000 from the tax year 2021 to 2022.

If your investments are made within an Individual Savings Account (ISA) then you don’t have to pay any tax on dividends or capital gains.

Over the years this allowance has changed, from the tax year 2017 to 2018 the allowance was £5,000, so it is a good idea to keep an eye on the new tax laws.

There are 3 different levels of tax band when it comes to the dividend tax.

The higher the tax band you are, the higher percentage you have to pay.

Tax bandThe tax rate on dividends over the allowance
Basic rate7.5%
Higher rate32.5%
Additional rate38.1%

Remember as investors we want to reduce the amount of risk and taxes we pay, it’s normally wise to invest within an ISA account, whether that is a stocks and shares ISA, Lifetime ISA or Junior ISA.

Summary

Now we have covered 14 different fees and taxes of investing you now know what to look out for and where to focus when cost-reducing within your portfolio.

Finding a brokerage which is competitive in fees but offers the features and investments you desire is the first place to start when costs reducing.

After finding the brokerage for you, next is figuring out how to reduce any further fees such as ongoing fees with funds & ETFs. Comparing similar types of investments will help you squeak out any further gains from good investments.

Now you know of 14 fees and taxes of investing, you can focus on avoiding the psychological trap of investing. 

Psychological Traps of Investing

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