Many of us think only of whether or not the investment account is doing well. However, there are some other things to pay attention to. Here are a few things that might undermine your investment earnings:
You might be surprised at how fees can erode your investment earnings. Any investment is going to come with fees. All brokers — including online discount brokerages — charge transaction fees when you buy or sell.
All funds come with fees. However, there is no need to pay more in fees than necessary.
You might pay 2% or more on managed mutual funds, but if you choose an exchange-traded fund or an index fund, you could likely pay less than 1%. Compare brokerage transaction fees as well. Some brokers charge a flat fee for all trades, and others have different fee structures.
Make sure you understand the fee structure, and choose investments that come with lower costs. Editor’s Note: I actually pay 0.19% in expenses with my target date mutual fund through Vanguard. So even some managed funds can be cheap on fees.
Inflation is one of those things we don’t think about a lot. However, inflation can erode your earnings. Inflation represents a reduction in buying power: The higher the inflation rate, the less your dollar will buy.
If you have an investment earning 7% annually, and inflation averages 3% annually, you are actually only earning 4%. If you have a bond earning 3% annually, and inflation averages 3%, you are breaking even.
If you have money in a high-yield cash account earning 1.3%, you are actually losing money in real terms. This is a bit of a simplification, but it offers an illustration of how inflation can impact your earnings.
Part of the reason that you are encouraged to diversify your investments across asset classes is to help you overcome inflation.
If you have all of your investment portfolio in cash or bonds, you might not be able to earn at a rate that keeps you ahead of inflation. Carefully consider how you might be able to take on a little more investment risk in an effort to beat inflation.
You should still have some investments meant to act as a safety net, but you can’t rely on them to offer adequate growth.
Your tax strategy can cost you down the road. You will have to pay taxes, of course, but you want to make sure you aren’t paying more than you have to.
Look at where your money is going. Try to put as much money as possible in tax advantaged accounts if you want to put off paying taxes. In Roth accounts, your money grows tax free (although you have to pay taxes on your income up front, before you invest).
Also, consider whether or not long-term investments might work for you. The tax you pay on long-term capital gains is different from what you pay on short-term capital gains. If you hold an investment for a year or less, your gains are taxed as regular income when you sell.
If you are in a higher tax bracket, this can be expensive. However, long-term capital gains, paid on investments sold after more than a year, are taxed a different rate, and capped at a lower rate. Consider the tax implications of your investments before you make your move, and look for ways to legally keep taxes from undermining your earnings.
There are items that can undermine your investment earnings. Have a plan for your investments, and look for ways to make sure you are keeping more of your money.
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