Whenever you buy or sell a stock, income taxes and transaction fees have an impact on your investment returns.
What Is Turnover?
Turnover occurs when you sell your investment and then re-invest the funds in another investment. When you buy or sell a stock, your broker charges you a fee for doing so. In addition, the sale will also trigger a gain or loss which will carry with it income tax consequences.
Brokerage Fees And Income Tax
The fee your broker charges you to execute a buy or sale of a stock is not tax deductible. Instead, the fee charged when you buy stocks is added to your cost and the fee charged when you sell your stocks is deducted from your proceeds. The result is a lower capital gain or larger capital loss.
If you are a frequent trader, the brokerage fees you pay become important since your investments are turned over more frequently and you must produce gains to cover your investment.
When you hold investments for a longer periods of time, brokerage fees really don’t matter as much.
Taxes Erode Investment Returns
As I mentioned above, selling a stock will trigger a gain or loss. If the stocks are held in non-registered accounts (that is not in an RRSP, RRIF, or TFSA), then the gain becomes taxable. For many investors the gain or loss is capital.
A capital gain of $1,000 earned in British Columbia by a person in the top marginal bracket would receive only $782 after-tax to reinvest.
Mutual Funds Can Sneak Up On You
Mutual funds are unique in that turnover can occur in the mutual fund itself and capital gains can be passed along to the unitholder. The mutual fund manager must sell stocks or other investments inside of the mutual fund to rebalance the holdings or to cover redemptions by other until holders. These sells will trigger capital gains or losses and the net capital gains are then passed along to the unit holders.
Mutual funds also have incur trading and management fees that reduce the funds rate of return. These management fees are also subject to GST and potentially to Ontario’s HST which further reduce the return on investment. These fees ultimately reduce the amount of gain you will receive when you sell or redeem the funds.
When you sell your mutual funds, you may have to pay a deferred sales charge if the fund was a back-end load fund. In addition, you will have to pay income taxes if your funds generated capital gains.
Be mindful of the fees and taxes when you are making investment decisions. Particularly,
- Minimize trading fees buy using a discount broker or hold your investments for long periods of time.
- Hold your investments in stocks or mutual funds for the long term and maximize your returns.
- Be aware that income taxes reduce the amount of you can re-invest.