Hidden fees, a common pitfall for a novice investor
Part 2 of our series on how to start investing
Dubai: If you do not have a specific area of expertise that makes you comfortable with investing, putting your money in broadly diversified funds is a good option. But one thing that is easily overlooked and important to understand is the fees you’re paying.
Paying high fees risks eroding a significant percentage of your earnings. Over time, investment fees can consume thousands of dollars in potential earnings.
Basic fees
Investment charges are broadly categorized into two. One is ‘fund management’ charges and the other is the ‘incidental fees,’ or minor expenditures associated with the investment. “These are revealed transparently by asset managers, as they are under significant scrutiny by regulators,” said Nisarg Trivedi, a Middle East director at Schroders Investment.
Beyond that, other fees could include one that is incurred by advisors for their services.
“If there are any other fees the investors should be made aware of or told about in advance, [but weren’t] maybe it’s time to switch investment managers,” Trivedi added.
The most common mistake that I’ve seen is an investor getting lured by high returns. While you may get too excited about the return side of it, you may not be able to understand the risks that are written in the fine print.
Other fees
With listed securities, there are exchange fees, trading fees and broker commissions. But if you are using a manager and able to invest in a fund, then beware of performance fees and quite often, ‘setup’ and ‘exit’ fees as well, said Anita Yadav, a seasoned markets expert with experience in diverse financial markets.
“Another element to be aware of is post-tax returns versus pre-tax returns as a lot of us just focus on the gross return, while not understanding that at the end, investments are tax payable and taxes are kind of a fee as well,” she said. Yadav added that there may also be foreign exchange charges, depending on whether you are investing in a product of a different currency.
“A lot of first-time investors are not sophisticated enough to understand or calculate those, so one needs to spend more time in due diligence to understand things before investing.”
Other pitfalls
Other challenges flagged for first-time investors are the struggles with information overload, unknown risks, limited capital, over-diversification of a portfolio, bad timing or simply not getting help. Some of the common mistakes are ‘following the herd’ and impatience, investment professionals said.
One of the world’s most successful investors, Warren Buffett, cautions against investing in businesses you don’t understand. This means that you should not be buying stock in companies if you don’t understand the business models. The best way to avoid this is to build a diversified fund portfolio.
Another thing to avoid is being hasty in making an investment call, which experts said is what a lot of the investors end up regretting, while adding that common mistakes include investing heavily in stocks and not creating and maintaining an emergency fund.
Also, way too often, when investors see a company they’ve put money in do well, it’s easy to fall in love with it and forget that it’s an investment. Always remember, you bought this stock to make money. If any of the fundamentals that prompted you to buy into the company change, consider selling the stock.
Lessons to learn
The key is to not get too emotional and let emotions cloud your judgement when investing, while also not getting lured by high-return investments.
It might be tempting to invest in a company that you like or because they were recommended by someone you trust, but investing with emotion is asking for trouble, Trivedi said.
A lot of times regrets happen when one bases their investment calls on what one sees in the media, Trivedi said, as he urged investors to keep “completely away” from news angles that are not “fundamentally” going to impact the return on investment.
“The most common mistake that I’ve seen is an investor getting lured by high returns,” Yadav said.
Fund managers may come and show you a fund’s historical performance, for example, a 10 per cent return versus another fund’s 8 per cent, and the investor becomes biased towards high return, she added.
Yadav suggested not to be tempted by quick-money schemes, because high return always comes with higher risks and, “while you may get too excited about the return side of it, you may not be able to understand the risks that are written in the fine print.”