9 questions to ask before investing4 min read . Updated: 19 Jan 2017, 08:07 AM IST
Investing is essential, it can even be fun when the returns are good. But it is not free. Make sure you ask the right questions to know all the costs associated with it
You would think that managing an investment portfolio for returns and risk should be sufficient to protect your interests as an investor. But costs and taxes are an integral part of financial products, and they can bleed the returns your money can earn. Not only does it take a bite out of your returns, but you miss out on compounding benefits too as this portion is no longer available to be invested and earn returns.
The impact of expenses on the returns can be significant. For example, an increase of just 1% in the annual expenses charged to an investment translates into a difference of close to 16% in the final value of your investment over a 20 year investment period. This difference goes up to over 20% if the holding period is 25 years. Similarly, taxes are dues that you have to pay on the returns that you earn which diminishes the amount you have to invest further and earn.
Ask and you shall know
Ask the right questions to be able to identify the costs, fees and taxes that drain your returns and understand their impact on your investments.
1. What are the fees that I have to pay at the time of making the investment?
These include, among others: commissions, brokerage and fees. Typically, these are one-time payments, linked to the transaction. They may be charged as a percentage of the value of the investment (such as brokerage charged by a stock broker) or a fixed amount (as charged by mutual fund distributors).
2. What is the cost of making, holding and redeeming the investment?
Investments such as shares and debentures, which are bought on the stock exchange, may require a demat and a broking account to make, hold and transact. All this can add to the cost of holding the investment. Some investments may charge a fee at the time of exiting an investment, such as the exit loads charged by mutual funds, which reduce the redemption value of the investment.
3. Are the fees negotiable? Are there regulatory limits?
Some expenses may have upper limits fixed by regulators, such as expenses and loads charged by mutual funds. The actual expense charged, relative to the upper limit, tells you how competitive an investment provider or financial service provider is. Others, such as charges of depository participants, may not have regulatory limits and you can negotiate to get a good deal. Beware, sometimes you may be charged for services that you may not even use.
4. Are there any on-going expenses?
Some products may charge a fee through the period of investment, for the expenses of managing the investment. The National Pension System, mutual funds and unit-linked investments are a case to point. Ask if there is a fee schedule that lists all the expenses.
5. Where can I find the information on costs charged on an investment product?
Typically, offer documents related to the investment product give all the information about costs related to the investment. Ask for an illustration that will describe how each type of expense will affect your investment.
6. What may attract additional fees?
Ask the investment service provider about actions that may attract additional fees or penalties. For example, not maintaining a minimum balance in a bank account may lead to a fee, early surrender of a National Savings Certificate (NSC) may imply lower interest than what was contracted, broking charges may be lower for higher value transactions.
7. What are invisible costs, if any?
Invisible costs are those that reduce your investment even though they are not listed as a charge or expense. For example, when a mutual fund buys and sells securities in the portfolio, transaction charges related to it are indirectly borne by the investors in the scheme. Ask about any such expense that can reduce your returns and how they work.
8. How will I be informed of the fees that have been charged to me?
An account statement sent by the investment or financial service provider will give details of the fees and costs charged to you. Remember that there are some expenses that are charged to the investment before the value is calculated. These do not appear on the account statement. Ask how often you will get this information and compare to see if there are any changes and seek explanations for the same.
9. What is the compensation that the adviser or distributor of the product or service will receive?
Ask about the adviser’s compensation so that you know that the product or service is being recommended in your interest and not for the benefit of the adviser. Relevant questions include: the amount of compensation, the basis of calculation and who it will be received from.
Some of the costs that you have to bear, can be brought down by shopping around and negotiating a better rate. Depending on the costs and taxes applicable, you can also modify your investment behaviour to reduce costs. For example, a person can instead adopt a strategy of less frequent trading to save brokerage and demat costs and taxes.
On their own, the costs may seem insignificant, but over time they can build up to a large sum. It is important therefore to take informed decisions to keep costs down to what is essential and to protect your returns from the ravages of costs and taxes.