Most of us realize that when you invest in stocks, you are going to pay some fees. However, some investors aren't aware of the deep extent of these hidden costs.
Whether you are a seasoned investor or plan to start investing soon, it's helpful to understand the many hidden costs associated with investing. Here are nine such expenses to keep in mind.
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Loads
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Loads are sales charges that come in two different varieties: front-end loads and back-end loads.
A front-end load is a cost investors face when they purchase a mutual fund. A back-end load is a fee investors must pay when they sell a mutual fund.
In some cases, the back-end load amount changes over time. For example, the cost might be 7% on shares sold in the first year, 6% the second year, and a lower load for each subsequent year.
Many actively managed mutual funds charge loads. The U.S. Securities and Exchange Commission (SEC) does not place limits on the loads a fund may charge. However, the Financial Industry Regulatory Authority (FINRA) — a self-regulatory organization — caps the load amount at 8.5% of the purchase or sale.
If you want to avoid loads so you can build wealth better, consider purchasing an investment that isn't actively managed, like an individual stock or an index mutual fund.
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Short-term capital gains taxes
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If you hold stocks for one year or less, profits are subject to short-term capital gains taxes. Essentially, this means that your profit from the sale of a stock you held for less than a year is taxed at ordinary income levels, which range from from 10% to 37%.
The exact amount you will owe in income taxes varies based on your income.
By contrast, selling after one year means profits are taxed at capital gains rates, which are 0%, 10% or 20%, depending on your income.
12B-1 fees
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Mutual funds often charge a 12b-1 fee to help cover the cost of marketing and selling mutual fund shares.
Just 30% of mutual funds do not charge 12b-1 fees, according to Investopedia. So, it's important to read the fine print if you want to avoid paying this sneaky fee.
The net investment income tax
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The net investment income tax (NIIT) is a 3.8% tax on specific investment profits for individuals with relatively high incomes.
For example, married couples filing jointly must have an adjusted gross income over $250,000 before the net investment income tax is applied. For individual filers, the threshold is $200,000.
If your income is high enough, this extra tax can add up quickly when you sell investments, including stocks.
Management fees
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A management fee is intended to compensate the manager of a mutual fund for their role in managing the portfolio. In some cases, management fees are charged on top of a load. However, in other cases, management fees are charged instead of a load.
Generally, management fees range from 0.5% to 2%. Although these fees might seem reasonable at first glance, these costs can add up over time.
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Redemption fees
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Some mutual funds require investors to pay a redemption share when selling mutual fund shares. This can be in addition to a back-end load
Although the SEC tends to limit redemption fees to 2% of the sales amount, this fee can still cut into your overall investment profits.
Trade commissions
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When you buy or sell stocks, a broker may charge you a trade commission. The size of the trade commission varies, but typically ranges from $5 to $35. If you make a lot of trades, your trade commissions bill can add up quickly.
The good news is that many brokerage platforms offer no-commission trading options. If you shop around for the right broker, you can avoid these costs.
Subscription fees
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Some investment advisors charge a subscription-based fee for their investment management services. If you opt to pay a recurring fee, the costs could ultimately eat into your portfolio's profits.
Before committing to a subscription fee, make sure the cost makes sense for your situation.
Account fees
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Account fees include a smattering of charges embedded into your investment account. Some of these extra fees include a paper statement charge, annual fee, inactivity charges, and more.
Before committing to a particular brokerage account, read the fine print to confirm you understand all of the different fees involved.
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Bottom line
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Growing a stock portfolio can be a great way to start building your net worth. However, many fees lurk when you start investing in stocks.
The best way to minimize or avoid hidden fees is to read through the fine print. There is a good chance that if you shop around for the right brokerage, you can reduce many of these costs.
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