Investing in New Zealand can be a great way to grow your money, but it’s not as simple as just choosing a stock or fund. There are hidden costs that can eat into your returns if you’re not careful. This article will walk you through these costs, helping you make smarter investment decisions and keep more of your hard-earned cash.
Brokerage Fees: The Ticket to the Market
Think of brokerage fees as the ticket you need to enter the investment world. When you buy or sell shares, managed funds, or ETFs through a broker, they charge a fee for facilitating the transaction. These fees can vary widely depending on the broker you use and the type of investment you’re making.
For example, traditional brokerage services like those offered by a bank can charge relatively high fees, sometimes $20-$30 per trade. Discount brokers, on the other hand, often offer much lower fees, sometimes even commission-free trades for certain investments. However, before jumping at the lowest fee, consider the services they offer. Do they provide research reports? Do they have a user-friendly platform? Do they have customer support you can easily reach? These factors can be worth paying a slightly higher fee for, especially when starting out.
Example: Let’s say you buy $1,000 worth of shares in a New Zealand company through a broker that charges $15 per trade. When you decide to sell those shares later, you’ll pay another $15. That’s a total of $30 in brokerage fees. If your investment only increased by $50, you’ve lost over half of your profit to fees! This is why it’s important to be aware of these costs and choose a broker that aligns with your investment strategy and budget.
Management Fees: Paying for Expertise
If you invest in managed funds or KiwiSaver schemes, you’ll encounter management fees. These fees pay for the expertise of the fund managers who are responsible for selecting investments and managing the fund’s portfolio. They are typically expressed as a percentage of the total amount you have invested and are charged annually. These can range from less than 0.2% for some index tracking funds, to over 2% for actively managed funds.
Essentially, you’re paying someone to make investment decisions on your behalf. But here’s the catch: higher management fees don’t always guarantee better returns. In fact, numerous studies have shown that many actively managed funds struggle to outperform their benchmark indices (like the NZX 50) over the long term, even before fees are taken into account. This is a crucial point for Kiwi investors: don’t assume that paying more means getting more.
Case Study: Imagine two KiwiSaver funds. Fund A charges a management fee of 1.5% per year, while Fund B charges 0.5%. Both funds generate similar returns for a few years before fees, say an average of 8% per year. After 20 years, the difference in your returns could be significant. Over time, the higher fees can substantially erode your overall investment outcome.
Action Tip: When choosing a managed fund or KiwiSaver scheme, carefully compare the management fees. Look for options with lower fees, especially if you are comfortable with a passive investment approach, such as index tracking funds. Indexed funds tend to have much lower fees than actively managed funds. Also, consider the fund’s performance record. Has it consistently outperformed its benchmark after fees? If not, you might be better off with a lower-fee option.
Transaction Costs Within Funds: The Deeper Dive
Even if you choose a fund with a reasonable management fee, there can be other costs lurking beneath the surface. These are the transaction costs incurred by the fund managers when they buy and sell investments within the fund. They are not always explicitly stated, adding to the hidden cost of investing.
Funds’ turnover rate measures how much the fund’s holdings are bought and sold over the year. Funds with a higher turnover rate generally have higher transaction costs, because each purchase and sale includes brokerage fees, bid-ask spreads (the difference between the price at which a security can be bought and sold) and potentially market impact costs. These costs can eat into your returns and are often not clear to the investor.
Practical example: Two funds might have the same stated management fee, but one operates with a high turnover and so has hidden transaction costs. These are passed on to the investor. This might be the difference between whether one fund has exceptional gains or whether another is mediocre.
Tax Implications: Keeping the IRD Happy
Taxes are an unavoidable part of life, and investing is no exception. In New Zealand, you’ll typically pay tax on any income you earn from your investments, such as dividends or interest. You may also be required to pay tax on any capital gains you make when you sell investments for a profit.
The specific tax rules can be complex, so it’s important to understand how they apply to your situation. For example, the tax rate on dividends can vary depending on your individual tax bracket. Capital gains are currently generally not taxed in New Zealand, unless you’re considered to be in the business of trading investments, or you purchase with the clear intention of resale; however, there has been public discussion around a capital gains tax in the future.
KiwiSaver and Tax: KiwiSaver has its own tax rules. Your contributions are taxed at your prescribed investor rate (PIR), which is based on your income. Your KiwiSaver provider will deduct the tax for you, so you don’t have to worry about filing a separate tax return for your KiwiSaver investments.
Action Tip: Consult with a tax advisor to understand the tax implications of your investments. They can help you develop a tax-efficient investment strategy and ensure that you’re complying with all relevant tax laws. Proper tax planning can help you minimize your tax burden and keep more of your investment gains.
Inflation: The Silent Thief of Wealth
Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. It’s a hidden cost that many investors overlook, as it quietly erodes the real value of your investment returns.
For example, if your investments earn a return of 5% in a year, but inflation is running at 3%, your real return is only 2%. This means that your investments are only increasing your purchasing power by 2% after accounting for the effects of inflation.
The Impact on Savings: Inflation is particularly detrimental to cash savings. While cash is generally considered a safe investment, it typically earns very low returns, often below the rate of inflation. This means that the purchasing power of your cash savings is actually decreasing over time.
Investment Strategy: To combat the effects of inflation, it’s important to invest in assets that have the potential to outpace inflation over the long term. These are generally shares and property. Inflation erodes money and money-like assets, meaning that physical and investment assets tend to go up in value.
Practical example: Someone who invests in shares in 2022 and 2023 may have seen a low or negative nominal return. However, inflation has been reasonably high in the same period. Once you factor in that inflation has eaten into money assets (cash) and the real value of shares, someone who invested in shares has done relatively well.
Opportunity Cost: What Are You Missing Out On?
Opportunity cost is the value of the next best alternative that you give up when you make a decision. In the context of investing, it’s the return you could have earned if you had chosen a different investment option.
Example: Let’s say you decide to invest in a term deposit that pays a fixed interest rate of 3% per year. While this may seem like a safe and guaranteed return, you could be missing out on the potential for higher returns from other investments, such as shares or property. If those investments generate an average return of 8% over the same period, your opportunity cost is 5% per year (the difference between the potential return of the alternative investment and the actual return of your term deposit).
Balancing Risk and Return: Of course, higher potential returns typically come with higher risks. Shares and property are more volatile than term deposits, meaning their prices can fluctuate more dramatically. However, over the long term, they have historically delivered higher returns than less risky assets. The key is to find a balance between risk and return that aligns with your investment goals and risk tolerance.
Action Tip: Before making any investment decision, consider the opportunity cost. Research different investment options and compare their potential returns and risks. Choose investments that offer a reasonable balance between risk and return, taking into account your individual circumstances and investment goals. Don’t just chase the highest returns without considering the potential downsides.
Time: Your Most Valuable Asset
Time is a crucial factor in investing. The longer you invest, the more time your investments have to grow and compound. Compounding is the process of earning returns on your original investment and on the accumulated returns. It’s a powerful force that can significantly boost your long-term investment results.
For example, if you invest $1,000 and earn an average annual return of 8%, your investment will double in approximately nine years. If you leave that money invested for another nine years, it will double again. This is the power of compounding in action. Start as early as you can so you have compound interest working for you, not against you.
The Cost of Delay: Procrastination can be costly. The longer you wait to start investing, the less time you have to take advantage of compounding. Even delaying by a few years can significantly reduce your potential returns over the long term.
Action Tip: Start investing as early as possible, even if it’s just a small amount. Make regular contributions to your investment accounts. The more time your investments have to grow, the better your chances of achieving your financial goals.
Emotional Costs: Staying the Course
Investing can be an emotional rollercoaster. Market fluctuations can cause anxiety and fear, leading to impulsive decisions that can negatively impact your returns. These are the hidden emotional costs of investing.
The Fear of Loss: The fear of losing money is a powerful emotion that can drive investors to sell their investments at the worst possible time, during market downturns. This is often referred to as “panic selling.” By selling low, you lock in your losses and miss out on the opportunity to recover when the market rebounds.
The Greed of Gains: Conversely, the greed of making money can lead investors to buy investments at inflated prices during market booms. This is often referred to as “fear of missing out” (FOMO). By buying high, you increase your risk of losing money when the market corrects.
Staying Disciplined: To mitigate the emotional costs of investing, it’s important to develop a disciplined investment strategy and stick to it, even during market volatility. Don’t let your emotions dictate your investment decisions. Remember your long-term goals and avoid making impulsive moves based on short-term market fluctuations.
Action Tip: Before you start investing, define your investment goals, risk tolerance, and time horizon. Develop a written investment plan that outlines your investment strategy and asset allocation. Follow your plan consistently, regardless of market conditions. Avoid checking your investment portfolio too frequently, as this can fuel emotional decision-making. Consider seeking advice from a qualified financial advisor to help you stay on track.
Due Diligence: Knowing What You’re Buying
Failing to do proper research before investing can be a costly mistake. It’s essential to understand the investments you’re buying, including their risks and potential rewards.
Company Research: If you’re investing in individual shares, research the company thoroughly. Understand its business model, financial performance, management team, and competitive landscape. Read the company’s annual reports and other financial disclosures. Look for reputable sources of information, like industry analysts and independent research firms.
Fund Prospectus: If you’re investing in managed funds or ETFs, read the fund’s prospectus carefully. This document provides detailed information about the fund’s investment objectives, strategies, risks, fees, and past performance. Understand the fund’s investment style and how it aligns with your investment goals and risk tolerance.
Action Tip: Before investing in any asset, conduct thorough due diligence. Don’t rely solely on the advice of others. Do your own research and make informed decisions based on your own analysis. If you’re unsure about an investment, seek advice from a qualified financial advisor. Never invest in something you don’t understand.
Currency Risk: A Global Consideration
If you invest in overseas assets, you are exposed to currency risk. Currency risk refers to potential losses arising from fluctuations in exchange rates. The New Zealand dollar’s value fluctuating against currencies such as the US dollar or the British pound will have an effect on returns earned overseas.
Example: if you invest in a US-based fund, and the NZD strengthens against the USD, the value of your investment (when converted back to NZD) will decrease. Conversely, if the NZD weakens, your investment will be worth more in NZD terms. Sometimes this can cause volatility.
Action Tip: Consider the added complexity of currency risk when investing overseas, and make sure your exposure aligns with your risk tolerance.
Liquidity: Can You Get Your Money Back?
Liquidity refers to how easily an asset can be bought or sold without significantly affecting its price. Some investments are highly liquid, meaning they can be quickly converted into cash. Others are illiquid, meaning it can be difficult or time-consuming to sell them.
Examples: Shares traded on the NZX (New Zealand Stock Exchange) and managed funds are generally quite liquid. You can typically buy or sell them within a few days. However, some investments, such as real estate or certain private equity funds, are less liquid. It can take weeks or even months to sell these assets, and you may have to accept a lower price than you would like.
Emergency Funds: Liquidity is particularly important for your emergency fund. You need to have access to cash quickly in case of unexpected expenses. Therefore, your emergency fund should be held in highly liquid assets, such as a savings account or term deposit.
Action Tip: Consider the liquidity of your investments when building your portfolio. Ensure that you have enough liquid assets to cover your short-term financial needs and emergencies. Avoid investing all of your money in illiquid assets, as this can limit your financial flexibility.
FAQ Section
Here are some commonly asked questions about the hidden costs of investing in New Zealand:
What is the best way to avoid hidden investment costs?
The best way to avoid hidden investment costs is to educate yourself about the different types of costs involved and to carefully research your investment options. Choose low-cost investment products, such as index funds. Understand the tax implications of your investments, and develop a disciplined investment strategy. It’s also crucial to seek advice from a qualified financial advisor if you’re unsure about anything.
Are KiwiSaver fees negotiable?
While KiwiSaver fees are not typically negotiable on an individual basis, you can choose a KiwiSaver provider that offers lower fees. Compare different KiwiSaver schemes and look for options with lower management fees and no hidden costs. Some providers also offer fee discounts for larger account balances.
How often should I review my investment portfolio?
You should review your investment portfolio at least once a year, or more frequently if your circumstances change significantly. This will allow you to assess your portfolio’s performance, rebalance your asset allocation, and make any necessary adjustments to your investment strategy. However, avoid checking your portfolio too frequently, as this can lead to emotional decision-making.
Is it better to invest in individual shares or managed funds?
The best option depends on your individual circumstances, knowledge, and risk tolerance. Investing in individual shares can offer the potential for higher returns, but it also requires more research and expertise. Managed funds offer diversification and professional management, but they also come with management fees. If you’re new to investing or don’t have the time or expertise to research individual companies, managed funds may be a better option.
What are the benefits of seeking advice from a financial advisor?
A financial advisor can provide personalized advice tailored to your individual circumstances and financial goals. They can help you develop an investment strategy, choose appropriate investment products, manage your risk, and navigate the complexities of the financial markets. A good financial advisor can also help you stay disciplined and avoid emotional decision-making.
References List
- Financial Markets Authority (FMA)
- Inland Revenue Department (IRD)
- Reserve Bank of New Zealand (RBNZ)
Ready to take control of your financial future and avoid the hidden pitfalls of investing? Don’t let hidden costs erode your returns. Start by educating yourself, comparing your options, and seeking expert advice. Take action today to build a secure and prosperous future for yourself and your family. Begin by researching low-fee investment options and taking the first step towards smart investing. Your future self will thank you!
