... and your net salary isn't really your net income.
A £1,000 bonus is a nice thing to receive, but if you're a higher-rate taxpayer who doesn't use any fancy tax avoidance strategies then all you'll get is £480, because the government takes a whopping 52% of it in the form of income tax and national insurance.
Welcome to the difference between gross and net. The gross gets the headlines, but what really matters to you is the net -- the money you are left with after all deductions.
When it comes to investing, you need to remember that your net return is after all of your costs, and these include many things other than your dealing commissions and stamp duty.
Tax is a cost
While dealing costs eat away at your returns, it is hard to avoid noticing these because they appear on your contract notes. The one that isn't quite as obvious is the bid-offer spread -- the difference between the buying and selling prices that you incur every time you trade, although it is built into the prices you pay and receive.
Many investors spend a fair bit of money on their investment activities, which in turn reduces their returns, such as account fees, specialist magazines and trips to annual general meetings.
Two other things that are often overlooked are the higher-rate tax liability on your dividends, if applicable, and capital gains tax if you're fortunate enough to realise gains of over £10,600 in the current tax year outside your Individual Savings Accounts (ISAs).
The problem is that these payments are made in the following financial year, instead of being deducted from your investments at source, and it's easy to forget to reduce your returns as a result.
One more thing. When valuing your portfolio, if you use the middle price (the average of the bid and offer prices) then you're overvaluing your holdings and thus your returns. That's because if you sold your shares you would only get the slightly lower bid price.
Love your ISA
Most people take out an ISA because of the income tax benefits, but once you build up a sizeable portfolio within an ISA then the exemption from capital gains tax can become an equally valuable benefit.
If I sold one of my biggest shareholdings, Dragon Oil (LSE: DGE), around 98% of the proceeds would be subject to capital gains tax. I obviously can't complain, but because they are held outside an ISA, this constrains my ability to deal with them -- I would lose the best part of a quarter of my investment if I sold the lot.
So, if a takeover bid for cash succeeded at anything up to a 30% premium to Dragon's current price, I would actually be worse off than if the bid failed because of the tax I would be forced to pay. But if the shares were held in an ISA I wouldn't have to pay any tax.
Net or gross dividends?
Another thing to watch out for is how dividends are quoted. In the UK, they are quoted net of basic rate income tax. But in countries like America and Canada, dividends are quoted gross and as a UK taxpayer you would never receive them as such because a 15% withholding tax would be deducted.
So if you're looking at the consumer goods giant Procter & Gamble (NYSE: PG.US), which currently pays a 3.6% dividend, you should bear in mind that, as a British taxpayer, this is really equivalent to just over 3.0%.
Why your net income isn't really your net
Most people who work are paid a gross salary, which is then reduced by tax and national insurance to produce a net salary. So what is their real income? Is it the gross or is it the net?
To my mind, an employee's income is their net after taxation and also after allowing for the many extra costs that they incur solely because they are working, one of the biggest of which is transportation to and from work.
Another example is the cost of clothing that is only worn at work. But some of the costs are more subtle, such as the lunch that is bought at somewhere like Sainsbury (LSE: SBRY) or Tesco (LSE: TSCO), rather than making it at home, because it saves time.
When I started working in central London almost 15 years ago, I closely tracked my living costs. That's because almost £200 a week was going on train and tube fares, accommodation and other related costs (mostly food), solely because I was working there. This came out of my after-tax "net" income, and the result was that my true disposable income was roughly half of that.
So, as far as I was concerned, my net income was really something like one-third of my gross income. And it's the net what counts, not the gross.
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> Tony owns shares in Dragon Oil, Procter & Gamble and Sainsbury. The Motley Fool owns shares in Tesco.
