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How Transaction Costs Can Affect Your Investment Yield

You’ve been warned.

 

Transaction costs are fees that you have to pay when you are investing in assets classes such as equities, bonds, investment funds and even property. These transaction costs are in the form of brokerage fee, bid-ask spread, sales charge, management fee and administrative fee. It is important to keep track of the transaction cost when investing because even a small percentage can potentially erodes your investment yield over the long run.

For example, if you were to invest in a company and assuming that the brokerage fee is 0.25% of the invested amount, you will need the stock price to move up by 0.5% to breakeven. This is because the brokerage fees are a two-way transaction where you have to pay when you buy and sell the stocks.

Therefore, besides doing due diligence on the companies and timing the market, investors also have to take note of the transaction cost for each asset classes.

Equity vs Investment-Linked Policies vs CPF

Let us take a look at 3 different types of investment instrument: Equities (i.e stocks), Investment-Linked Policies (ILPs) and the CPF Special Account

Stock Investment-Linked Policies CPF Special Account
Amount To Be Invested Per Year

$6,000

$6,000

$6,000

Transaction Cost

$25 ($25 or 0.25% whichever higher)

1st Year: $5,100

2nd Year: $4,200

3rd Year: $3,000

4th – 9th Year: $0

10th Year Onwards: 102% of premium will be invested

Hidden Charges*: 4%

NIL

Amount Left For Investment after Transaction Cost for a year

$5,975

1st Year: $864

2nd Year: $1,728

3rd Year: $2,880

4th-9th Year: $5,760

10th Year Onwards: $5,875

$6,000

Returns after 10 years assuming 4% p.a

$74,573

$55,113

$74,918

Investment (Capital Gain) Yield 24.2% -8.145%

24.9%

*Hidden Charges includes administrative fee of $10 per month (translates to 2% p.a), 1-1.5% of management fees and 1% account maintenance fee.

Read Also: The Ugly Truths Behind Investment-Linked Policies

Certainly, there are many pros and cons for each of the investment methods (or cons and cons) such as the ability to cash out our investment and the ability to generate our assumed 4% annual return. However, it is not difficult to see how the amount left after incurring transaction cost makes a difference in the investment yield. For example, money in your CPF account does not require you to incur any transaction cost for you to earn your returns. As for ILPs, it appears that for you to be able to beat the returns offered by CPF, you would probably need to earn an extremely high return over the long term to be able to cover the transaction cost and also earn a return.

Dollar Cost Averaging

Now let us take a look at Investor A who uses dollar-cost-averaging and Investor B who invest in a lump sum at the end of each year.

Investor A Investor B
Amount Invested

$1000 per month for 1 year

$12,000 lump sum

Transaction Cost

$25 per month

$12,000 *0.25% =$30

Returns after 10 years assuming 4% returns p.a

$17,319

$17,718

Investment Yield

44.3%

47.7%

As for dollar-cost-averaging investment method and investing as a lump sum, the difference in investment yield is slightly less significant. Moreover, dollar-cost-averaging allows you to buy lesser units of shares when price is high and more units when price is low, thus allow you to average out the prices of stocks overtime. On the other hand, the downside of lump sum investment is that one needs to time the market correctly to get the “cheapest possible” price to maximise capital gain.

The transaction fee of 1% or 0.25% may seem small, however all these little fees will add up to a sizeable amount, especially when we extrapolate it over a long time. Therefore, transaction fees should not be taken lightly. Hence, investors really have to read the terms and conditions for hidden charges and calculate the different options carefully before embarking on their investment journey.

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