How expenses affect your investment gains

With ever increasing inflation the mere mention of the word 'expense' irks everyone, and rightly so. The way inflation is rising and the constant price hikes, household monthly budgets are going for a toss. Just as you worry about your household expenses you must know that even your investments have expenses.

More importantly, you have to constantly monitor them because they have a direct impact on the returns gained from your investments. The simple thumb rule is: Higher expense charges will lower your net profit to that extent.

So, if you are planning to invest in equities, mutual funds, gold, real estate, or insurance check the kind of charges they are taking away from your investments. Choose a plan that has minimum of the charges mentioned below.

Let us have a look at what these expenses are for different kinds of investments and insurances:

Let us start with investments:

Equities

There are various ways in which an individual can invest in them: Direct investments either through a broker account or an online trading account. For both kinds of investments, you have to pay the following expenses: 

The author is a certified financial planner and can be reached at dhanplanner@rediffmail.com.

Become a fan of Sheetal Jhaveri

PMS is a type of service offered by portfolio managers to manage your money by investing in various products as per your requirements. Most of the PMS only concentrate on equities. There are some who offer hybrid products. The fees generally charged depends on the arrangement you have selected.

Without profit sharing or fixed fees: A management fee of fixed amount is charged which varies between 2 per cent to 2.5 per cent per annum of the total amount given for portfolio management. The brokerage is generally charged at 0.5 per cent (varies from company to company).

Additionally there will be custodial charges, incidental charges and taxes.

With profit sharing or performance-linked fees: The management fee charged is generally 1 per cent to 1.5 per cent per annum. There is generally a hurdle rate that is minimum rate of return before their profits are shared. Hurdle rate is generally kept at 10 per cent. There is also return-based fee that is charged on returns over and above the hurdle rate.

The return-based fee will again vary from company to company. The brokerage is generally charged at 0.5 per cent (again will vary from company to company). Additionally there will be custodial charges, any incidental charges, and taxes.

Expenses in mutual funds fall under 2 heads: one time expense and recurring expenses.

One time expense: Entry and exit load. As entry load is now abolished unless an investor is going through a distributor and they agree upon an upfront fee, there is no other entry-level expense. Exit load is only applicable if you redeem your investment within six months to one year depending upon scheme to scheme. If you stay invested for more than one year than there is no exit load.

Recurring expenses: These expenses are charged annually by the fund. The expenses are declared twice a year in the form of expense ratio. These include:

• Fund management expenses: Generally not more than 1.5 per cent of the average daily expenses
• Marketing and selling expenses: Generally 0.5 per cent of the average daily expenses
• Custodian fees: Generally 0.25 per cent of the average daily expenses
• Investor communication: Generally 0.2 per cent of the average daily expenses
• Registrar and transfer agent fees: Generally 0.15 per cent of the average daily expenses
• Trustee and audit fees: Generally 0.15 per cent of the average daily expenses
• Interest cost: Incurred in debt funds and will vary depending upon the type of fund

In order to protect the investor from unnecessary inflated expenses, mutual funds can charge a maximum expense of 2.5 per cent (equity funds), 2.25 per cent (debt funds as the management in this fund is comparatively less), 1.5 per cent (index funds) and 0.75 per cent in funds of funds.

Real estate: Has a list of expenses

• Stamp duty: Will vary from state to state and the cost of property
• Broker commission: Again varies from area to area
• Registration fees and legal charges

Gold

Gold ETF are the same as exchange-traded funds and hence the expenses are the same. If you buy physical gold, that is, gold coins or bars for investments then the cost of the coin or bar will include making charges and service tax. Also, if you have a bank locker to keep your gold then the rental charges of the locker also needs to be considered.

After having a look at the expenses in investments there is one more important area where the expenses have to be taken into account.

Insurance

Unit linked investment plans are the latest buzz in the insurance world. But have any of you looked at the different types of expenses which you will incur to keep the insurance policy going? Not all agents inform you about this. Let us have a look at the various heads of expenses one need to consider while opting for ULIPs:

• Fund management charges
• Administrative charges
• Mortality charges (will increase with increase in age)
• Service tax: 10.3 per cent
• Fund switching charges: Free till 4 to 5 switches per year but after that you are charged
• Partial withdrawal charges: Partial withdrawal is allowed after initial three years and charges can go as high as 30 per cent to 40 per cent of the amount
• Premium redirection or alteration charges: Is Rs 250 per request
• Premium holiday charges: The agents will tell you that you can stop your premium after first three years but many insurance companies charge premium holiday charge for not paying the premium
• Surrender charges: The charges will vary depending upon different plans but all the above heads are very much present. Please clarify all the charges before thinking about taking a ULIP plan

The whole point of discussing these expenses for various investments and insurance is to make you aware that these expenses affect your profitability. However small these amounts may be they cannot be ignored. So be informed!