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Lesson # 3 of our TOP TEN Investment Principles – Costs Matter

Costs Matter

Various research papers have shown that there is a high correlation between low-cost investments and higher returns and we believe this to be true.

That is why we believe it is always wise to closely examine the cost of your investment before making the investment - because the higher the costs, typically, the less money in your pocket at the end of the day. This is not to say you should only focus on costs. You should also focus on the risks and returns of the investment and the services you require (if you are not good at or not interested in managing the investments yourself, then it “pays” to have a professional do it for you).

Take someone who would like to invest in a diversified managed fund. The costs to consider are:

· Buy Costs – the one-off cost to buy the investment at the beginning of the term

· Sell spread – the one-off cost to sell the investment at the end of the term

· The Investment Manager Fee – charged annually by the manager of the fund

· The Administration Fee – payable annually to an administration provider to allow you to buy and sell your investment online and provide performance and tax reporting amongst other things

· The Adviser Fee – charged by the financial planner if you use one

· Income Tax – tax payable annually on the net income (income less deductible expenses)

· Capital Gains Tax – tax payable on the net capital gain (sale price less cost base)

Depending on the range of fees you pay, it would be possible to pay:

· Buy and Sell Costs - between 0.1% and 1.0% in at the beginning and end of the investment.

· Ongoing Costs (excluding tax) - between 1.00% and 3.15% P.A (this figure assumes you are using an Adviser and Administration Provider and an actively managed fund or low-cost index fund)

· Income Tax - up to 0.47% P.A of the taxable income

· Capital Gains Tax - up to 0.47% P.A of the taxable capital gain

Based on a $500,000 investment held for 10 years in a diversified managed fund returning 6%P.A in income and 6% pa in capital gains (the actual 10 year returns on a popular diversified index fund as at August 2021) the difference between the lowest cost option and the highest cost option over the life of the investment would be:

· Buy and Sell Costs - $1,564 vs. $14,664 – a difference of $13,100

· Ongoing Costs - $73,570 vs. $224,548 – a difference of $150,979

· Income Tax - $0 vs. $184,532 – a difference of $184,532

· Capital Gains Tax - $0 - $90,546 – a difference of $90,546

· Total Costs - $75,134 vs. $514,290 – a difference of $439,156

Investing in residential property also involves costs. I have listed some of the more common costs with example estimates below:

· Stamp Duty on the purchase – payable to the State Government and between 3.6% and 11.6%

· Legal Fees – approx. $2,200 on purchase and sale

· Agents Selling Fee – approx. 2.2% of the sale price

· Agents letting fee – approx. 5.5% pa of the rental income

· Strata Fees (for units) – approx. 0.5% pa of the purchase price

· Rates – typically at least $1,000 pa

· Maintenance – the cost to fix damages and breakages – can be a few thousand dollars pa

· Borrowing costs – the interest rate if you have borrowed to purchase the property

· Land Tax – between 1.6% and 2.0% pa of the land value above the general threshold

· Income Tax - between 0% and 0.47% pa of the taxable income

· Capital Gains Tax - between 0% and 0.47% of the taxable capital gain.

Using an example of a $500,000 unit (assuming 3.5% pa rental income, 6% pa capital growth, no borrowing and no land tax), the costs for a 10 year term would be:

· Buy Sell Costs - $40,586

· Ongoing Costs - $78,590

· Income Tax – $0 to $59,309

· Capital Gains Tax – $0 to $77,108

· Total Costs - $119,176 - $255,593

Whilst the total costs seem lower than the managed fund example, due to the higher income assumption (6% for the managed fund v 3.5% for the residential unit and I have assumed reinvestment of income for the managed fund but not for the residential unit) the return after all costs for the managed fund was returns for the managed fund $1,002,846 versus $868,495.

Whilst the examples and the numbers can easily be debated, the point is clear: costs (including tax) matter.


@Paul Barrett of Absolute Wealth Advisers is one of Australia's most experienced Private Wealth Managers. He is a financial expert in high net wealth divorce, estate management and inheritance. Contact him here

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