Good morning RIPvestors,
welcome to another post in the investing series, where I gradually introduce you to the world of investments and go deep on topics I have some experience with, mainly related to investments in Switzerland.
Other posts in the Investing series:
- Investing basics
- Financial Investing
- Funds Investing
- Fees & Taxes
- Stock Price and Market Model
- Investor Profile and Lifelong Investing Strategy
- ETF 101
- Stick with it
- My take on Cryptocurrencies – Part 1: The Ugly
- Interactive Brokers 101
In this post I’m going to show you the importance of fees and taxes in investments, with a focus on Switzerland brokers fees. We’re not going to take a deep look at assets related fees since my only experience is with funds’ fees – and we’ll take a look at that in one of the following posts in this series.
In the previous post I left you with a lot of unanswered questions. Sadly we’re going to answer to almost none of them in this post, just throwing a lot of confusion (read: data and pessimism) on the table.
“Oh, finally RIP… I was waiting for this series to continue! What’s next? I heard that MyCoolIndex went up X% last year, if I invested back then and sold everything today now I’d have X% more, what a shame!”
That’s sadly not true my imaginary friend, and that’s what we’re going to talk about today: actual investing will bring you slightly less money than theoretically expected, due to some kind of second principle of thermodynamic applied to investments. Like friction slows everything down and generates heat, every time you move a Dollar you experience financial friction and your money evaporates into nothing. Well, not exactly into “nothing”, but into someone else’s hands. Sadly, frictions in finance are everywhere, not just on money movements. They take several names, mainly taxes and fees. Taxes are on wealth (nominal value of your assets) and/or profits (dividends, capital gain) so they are there to smoothen the good news: reducing the gains. Fees are there anyway, as permanent bad news.
Before moving on, please read deeply this article by The Simple Dollar on the math behind fees compounding. Essentially, even a small difference of decimal percent points between recurrent fees will lead to gigantic absolute differences if given sufficient time. Here‘s another detailed article if you want to know more.
Ok, let’s take a look at fees and taxes.
Investing is not a zero sum game. It’s not but due to two opposite factors:
- it’s a less than zero sum game, since every action has a cost/fee.
- it’s a greather than zero sum game since economy grows over time and everyone win.
We covered the expected greater than zero (I hope) so far in this series. Here let’s focus on the costs, the frictions, the energy loss due to transactions and managements.
We agreed you shouldn’t buy shares of an actively managed fund, right? Anyway, passively managed funds have costs. Usually they are costs proportional to the invested capital and to the number and volumes of transactions.
Brokers/banks may charge you for the custody of your securities. Depending on what you invest on (banks usually offer you discounted fees if invest in the funds they manage), you may incur in:
Account opening/closing fees.
Say you want to start investing and don’t know what to do. You find a mediator (a bank, a broker service, a financial institution, the government,…) and want to use them as a tool to buy, sell and hold your assets. You probably need to open an account with them. This operation alone may have costs and/or other kind of requirements like, for example, you may also need to open a checking account with the same bank, you may need minimum initial deposit, you may be forced to accept an expensive initial consultation with a physical person to assess your risk tolerance, et cetera.
Same is true for closing the account. Please double check before opening an account with them. Must say that these kind of entry barriers are not very popular, since everybody wants to have you in with them.
I’ve also heard you can get “credits” for opening a brokerage account with some firms. I’ve not found yet someone who did it Not in Switzerland though. We use to respect thermodynamic principles. There are referral bonuses though. Like my favorite broker firm does! Note that the above link is not a referral link (yet), just a link to the referral program.
In the long term, opening/closing fees are negligible anyway since they are only paid once.
Your brokerage account is like a virtual world where you buy and sell things which reflects on moving number in databases. On its own, it’s an interesting world. But you probably want to connect it to the real world, where real money moves around. To do so you must be able to deposit money into your account and to withdraw from it whenever needed. Another source of friction.
On top of that you may need to take into account money transfer fees at source. Real case scenario: you have a bank account with bank X, you want to transfer money to entity Y that handles your investments. You instruct bank X to wire a certain amount of money to entity Y. Both X and Y may charge you for this.
I’ve actually found firms that issue a deposit bonus (as always, not in Switzerland), like forexbroker – well, forget about that: after a very deep 10 seconds research I’ve found it’s considered a mostly scammy broker.
Usually deposits are not charged by the entity Y (they want you to deposit money) but your bank X may apply transfer fees. I’m lucky enough that CHF deposits from my “CH – CHF – Individual – checking” account (row 19 on my NW) are not being charged, despite the bank and the underlying broker bank account for CHF deposits are in different nations (CH vs UK). Sadly, USD deposits from my “CH – USD – Individual” account (raw 23, different bank in CH) to the underlying broker bank account for USD deposits (which is in US) are charged a little by the CH bank.
Same is not true for withdraws. Here X and Y goals are reverted. Y doesn’t want you to take money out. For instance, with interactivebrokers, (a.k.a. IB) I get a free withdraw per calendar month, then each subsequent withdraw is charged with a flat rate of 11 CHF at the moment (September 2016).
Anyway, even though these fees can be somewhat recurrent (you want to deposit/withdraw with a higher frequency compared to opening/closing accounts) in the long term they don’t mind too.
Yearly custody fees
Here’s the first fee that matters a lot!
Custody fees are usually proportional to the invested capital and are paid out yearly or quarterly. They are in the range 0 – 1% of the invested capital. 0% is very rare, the only broker I’ve found that offer such a good deal in Switzerland is again IB, but you need to have invested at least 100K USD or else you’ll pay 10 USD per month.
Custody fees are strong forces that accumulates over time and cost you a big chunk of your invested capital. Again, let’s skip the math here and please take a look at this article on how a 1% fee will eat 25% of your investments in 40 years, or play yourself with this Investment Fee Calculator.
If you choose your bank as investment broker, you’ll probably discover that they have 2 separate custody fees: a higher one (0.5 – 1.0%) for holding your generic securities and a lower one (0 – 0.5%) for holding securities issued by them. It’s a scam, run away! Their securities are managed funds with obscure – but high – management costs. I’ve chatted with both UBS and Credit Suisse and they are similar in this. Last time I chatted with UBS they had a quarterly fee of 0.14% (and somewhere around 0.04% quarterly for UBS managed assets) but at the time of writing they changed it to annual model, with a 0.35% base fee that can grow till 0.75% for non traditional funds outside Switzerland. 50% discount for UBS issued assets (which are in Switzerland and are not non-traditional funds, so 0.17%). Here‘s the link to the up to date information. Scam anyway.
Same holds true for Credit Suisse, even though their fees seem slightly lower.
If you plan to be a long term investor (and we’ll see why you should in next episode), choose a broker that applies the lowest custody fees.
So far you opened a broker account with entity Y and wired some money over. It’s time to buy securities! Is that free of charge? Of course not! Each trade has some friction in the range 0.05% – 3% of the value traded, sometimes with lower/upper barrier fees.
Yes, I’ve seen 3% trade fees at UBS for pension Pillar 3a funds like Vitainvest 25. Note: they state in the bullet points list under “Your benefits” the fact that the fund has an “Active management” so that “the weighting is always in line with the latest market forecasts”… wow thanks a lot UBS, I’m so lucky to have this team of financial expert to help me managing a fund that should simply match a Swiss Market Index like SMI or SPI with 25% of its capital and invest the rest in a Swiss Bond Index (SBI).
My experience, again, is with IB that has a dual trade fee model: Fixed vs Tiered. I actually don’t understand in which cases the Fixed model is better, because to me it seems the Tiered model is always better. Anyway, if you know a use case when Fixed is better, please write it down in the comment section of this post.
The IB Tiered model charges 0.08% of the trade value, assuming we are all trading less than a million CHF at a time. 0.08% – or as seen sometimes 8 basis points – means 8 CHF for a trade of 10K CHF. Fair enough. There’s a minimum of 1.50 CHF per trade, which means trading less than 1875 CHF in a single transaction ends up being more expensive.
Trade fees are relevant, you’re going to trade a little bit over time. Anyway, as we’ll see in next episode, if you’re a day trader you care more about these fees than if you are a buy&hold investor, like you should.
Brokers offers a wide variety of services and premiums you can benefit from. Do you want real time stock exchange data instead of 15 minutes delayed? If you wonder why it matters, maybe you’ve never heard about high frequency trading. Well, actually the high frequency guys don’t use a broker, they interact directly with the stock exchange. Anyway, if you are a day trader and want to make a fortune by timing the market and trading several times a day you may need better market data.
If you’re like me and don’t want to care about this stuff you don’t need any premium package.
Are you managing your wealth or asking for help? This is not free. Advisers may eat another big chunk of your money via consulting and performance fees.
You should simply run away. No value added.
Funds management fees
Essentially, we can forget about minor fees like deposit/withdraw, open/close and premiums. Understanding custody and trade fees covers 95% of what you should really know about your broker. We’ve done with it.
Now it’s time to dig a little bit on fees related to the security you want to invest into. Note: I may use the words security or asset inconsistently across this series, but I mean the same thing. If I want to be specific I say stock, fund, bond,…
If you buy stocks, there are no other hidden costs. You follow the stock price on the internet (Yahoo Finance, Google Finance, your broker web/app interface) and that’s all. If you buy a fund, there are fund management costs. We’ve seen them in a previous post of this series and we said they strongly depend on the fund being actively or passively managed. Anyway, the fund management fee is never (as far as I know) paid out directly, but it’s withheld from the fund’s capitalization and reflected into the fund’s share price. It’s universally called Total Expense Ratio (TER). As we’ve seen it’s in the range 0.07 – 3%, yearly.
The TER is another fundamental number to try to keep as low as possible! Two funds who track the same index can be compared using their TER. The lowest, the better!
Well, it’s not true.
Essentially, taxes are other fees. Usually bigger fees. There are several kind of taxes on investments:
The concept is that you pay a yearly tax proportional to your NW. Proportional is not the correct word since, as every other tax does, the tax brackets are higher the higher your NW is. This is something new for me, since in Italy we don’t have a wealth tax (for now).
Sadly, Switzerland has a wealth tax that can reach 1%, yearly, of your wealth. Following this or this sources of information you can see that where I live (German speaking Switzerland, lower taxes) wealth tax for a NW of 1,000,000 CHF is between 0.1% and 0.4%.
Since, all your after-tax investments contribute to your wealth, you need to take this into account as an extra cost. Pension Pillar 2 & 3 don’t contribute to your wealth-taxable NW.
When companies distribute a dividend and you own stocks of that company, you earn the dividend. In almost any country the dividend is taxed either as income or separately. In Switzerland dividends are income. In Italy there’s a flat “financial return” tax bracket by financial asset category. Here‘s a link (in Italian) about rates. Currently, it’s 26% on stocks and funds.
Another problem is when the company is traded in a stock market in a different country respect your residence. Sometimes you may incur in double taxation. For example, US tax authority (IRS) withholds 15% of dividends, like a tax at source. If you’re Swiss resident and want to avoid problems you can use the DA-1 form to reclaim that tax.
Capital gain taxes
When you sell something that you paid less than that, you have a capital gain. This is taxed on several countries, like US and Italy. Luckily, Switzerland doesn’t have a capital gain tax. Italy has a flat 26% capital gain tax.
Lump Sum Taxes
In Switzerland – like in US – you may withdraw under certain circumstances (leaving the country, buying a house, starting a company) from your Pension Pillars 2 & 3. When you do, you pay taxes on it since your Pillars are pre-tax money. Luckily, you don’t pay full income tax but a fraction of it. You can calculate how much you would pay withdrawing from your Canton using this calculator, and then check how much you would pay withdrawing from Schwyz Canton clicking here. Note: you can always move your assets to another Canton before withdraw.
Anyway, if you invest your Pillar 3 (I’m not aware of investment opportunities for Pillar 2) you need to take into account these extra taxes you’re going to pay at withdrawal time. I’m accounting for this tax on my NW spreadsheet (row 58) with a tax rate of 5.3% which correspond to the expected rate in my Canton for the expected capital I’ll withdraw.
trading stocks on some stock market may incur in extra trade taxes. Trading stocks on the Swiss stock market as a Swiss resident you pay the Swiss stamp tax. I’m not aware about italian situation on this.
Costs (Taxes and Fees) Recap
As we’ve seen, all these fees and taxes will likely kill your strategy. The 4% rule is just a study based on S&P500 performance, assuming no fees and no taxes. Well, let’s say assuming no capital gain tax and gross withdraws. An ideal situation.
When planning for your actual situation you need to take these costs into account. What it means is usually a couple of things:
- You may discover that your plan is not viable in your target country. In my case, Italy is not well suited for living off of investments thanks to too many taxes.
- You may want to revisit your Withdrawal Rate, adding few safety margins. That’s why I’m not planning to go for a 4% but a 3.33% instead.
Open question: I didn’t find a nice non-standard retirement calculator for Switzerland/Italy. Kudos to who’ll point me to a suitable one 🙂
Now, back to your strategy my dear friend!
See you on next post on this series.