• wblogo
  • wblogo
  • wblogo

Understanding Steps, Costs Of Making A Trade - A Family Office's View

Blu Family Office, 25 June 2018

articleimage

This is the latest in a series of commentaries by the European family office firm.

Here is another in a regular series of commentaries by Blu Family Office.

The process of moving money from one place to another is pure beauty in motion. There are so many different components interacting with so many different functions, the whole thing is globally connected and brutally efficient. How one uses this enormous system can have a massive impact on one’s wealth and we are not even going to get into the whole concept of a random world. Laying out all the steps, understanding why and how one can do things is key. And so here it is, the complete road map from beginning to end and everything to do with investing our money.

Step one is undoubtedly the most important in that we have to decide what to actually do with our money. Or to put simply, what are we going to be investing into? This decision warrants careful consideration and expertise to weigh up and analyse all the various options (of which there are many across the entire investment universe, such as real estate, cryptocurrencies, bonds, equities and commodities or hedge funds). Typically, people outsource this function and get charged a management fee or investment advisory charge. Of course, we could do it ourselves, but there is a lot to consider and we want to get this right, which would take time and money (opportunity costs). In today’s market place, the cost to perform this step is about 1 per cent (on the amount of the assets).

Step two is where we have to do the planning for our investment, and that mainly involves taxes. Very simply, if we were to buy the investment outright and sell it at a profit, we would be liable for capital gains or income tax immediately. If we were to use a tax deferment vehicle, such as a SIPP, ISA or trust, we would only be liable on the tax when we take the money out of the vehicle. This allows us to earn rewards with the money we owe to the government. It's perfectly legal and there is a large (pension fund) industry set up specifically for this purpose. Of course, nothing is free in life, particularly when you have service providers, e.g. the people who run the tax deferment vehicles that know that you are saving a lot of money and charge you very highly for that privilege. Accordingly, the costs of setting up and managing these vehicles can vary widely from as little as 0.10 per cent to as much as 2 per cent and more, relative to the size of the investment. All of which needs to be carefully considered versus the amount of tax one can expect to save over the life of the investment.

Step three is often overlooked, and it may have to do with the excitement of having finally decided on an investment. For most people, putting one’s money at risk can be nerve racking and hence emotional, particularly if things go really well (greed) and most definitely when they go wrong (fear). As such, one can easily overlook the details of how to best implement the investment and which product to buy (or sell). For example, say we like the stock market and we want to invest in equities, there are literally hundreds of different ways of doing that, from buying single stocks, to ETF’s, to futures, warrants or options.
They all bear different costs, such as how we keep them (custody) and administer them (reporting). They also bear different risks, which is why we need to understand the different products and their total costs, which again also takes time and expertise. On average, people pay 0.5 per cent in this step.

Step four is quite interesting in that this is the most complex part of the transaction, but it is the one that has become so marginalised and commoditized that it is now the cheapest step of all. We are of course talking about execution. This is where you actually move your money from one investment (or account) to another and buy (or sell) the investment you want to make. Sticking to our example of equities, we would hence buy shares on an exchange which incurs charges (e.g. London Stock Exchange). There is the so-called bid-ask spread (difference between the best price to buy versus the best offer to sell), slippage (market impact on your investment) and of course the commission to the broker, who is authorised to deal on the exchange. All in, one should expect to pay about 0.35 per cent in this step.

Step five is the most difficult as we have to decide how we are going to trade our investment. Ever heard of the old trading rule, “know when to get out”? When we make an investment, we are at risk with the money we have put to work. The question is, how much of that money are we willing to lose? If we don’t have the answer to this question before we make the investment, then we are gambling dangerously with our wealth. We have seen countless examples of people holding on to bad investments because they didn’t know when to get out. Think of the people who bought telecom stocks, such as BT or Deutsche Telekom in the late nineties – 20 years later these shares are still down more than 80 per cent from their highs. And there will be many of these people who continue to hold onto these stocks on the mistaken belief that everything only ever goes up in the long run. Knowing when to cut your losses or take profits is complex and notoriously difficult (timing), which is why the cost of this step is almost impossible to quantify. But please bear in mind, that we pay hedge fund managers 2 per cent to manage this type of thing for us when we buy their strategies.

Finally, we also have the accounting of the investment to consider. After all, anything we do with our money must be reported to the tax authorities. Some investments are undoubtedly easier to account for than others. Think buying shares in Vodafone versus buying a Gold mine in Tanzania. In either event, we are going to be paying something to somebody as we endeavour to find the best way to manage our tax affairs and the reporting thereof.

All in, the total costs to make an investment are considerable and reducing them is very difficult. You don’t want to be penny wise and pound stupid as they say, whereby you may be saving a lot of money by going to a cheaper service provider but incurring the risk that your money is not safe. In this market place, you get what you pay for, and not getting these steps right can have a much higher impact on our wealth than costs alone. The most important value we can add, is to make sure that we don’t overpay for services or worse, we incur unrewarded risks in the way we invest our money.

Latest Comment and Analysis

Latest News

****************************INSERT INTO `wealthbriefing_cms`.`cms_tx_2020` ( `tx_date`, `tx_user`, `tx_pub`, `tx_page`, `tx_article_id`,`ip`,`type`) VALUES ( NOW(), '', 'WB', '/html/article.php', '179913', '3.219.167.194', '')************|||||||||||||||