Carrying Charge: What It Means, How It Works, Example

What Is a Carrying Charge?

A carrying charge is a cost associated with holding a physical commodity or financial instrument. Carrying charges increase the cost of an investment, which means they put downward pressure on that investment’s expected return. Investors should carefully consider the likely carrying charges involved in an investment before deciding whether to proceed. Carrying charges are also sometimes referred to as an investment’s cost of carry. Insurance costs are one example of a carrying charge.

How Carrying Charges Work

As noted above, carrying charges are the costs associated with holding financial assets. These charges vary depending on the type of investment held. Carrying costs are also known as carrying costs or holding costs.

For instance, the carrying charges may be substantial if an investor decides to take physical delivery of crude oil. In addition to requiring a storage vat to hold the oil, the investor may also incur transportation, labor, and insurance costs. In this case, the high carrying charges could potentially make the entire investment unprofitable. 

In other cases, carrying costs could be much more modest. For instance, an investor who purchases an exchange-traded fund (ETF) may pay a management fee of less than 1% per year. In this scenario, the 1% carrying charge is unlikely to be a major factor in determining the investment's profitability. This is one reason why lower-cost investments such as ETFs are so popular, particularly among retail investors.

The price of a given security often already reflects the carrying charges involved in purchasing it. This is the case with commodity futures contracts. Under normal circumstances, their prices tend to include their spot price as well as any carrying charges involving storage. When you purchase a futures contract (rather than the commodity), you benefit from not having to incur those carrying charges until the settlement date.

Types of Carrying Charges

The following are the most common types of carrying charges in the financial world:

• Insurance payments
• Interest charges
• Storage or holding costs
• Taxes
• Utility costs
• Handling and transport costs (associated with picking and moving the asset)
• Obsolescence and damage charges (to account for deterioration or waste)
  

Example of a Carrying Charge

To illustrate this potential arbitrage opportunity, consider the case of a commodity whose spot price is $50. If the carrying charges associated with that commodity are $2 per month, and its one-month futures price is $55, then an investor could make a $3 arbitrage profit by simultaneously buying the commodity at the spot price and selling it for delivery in one month at its one-month futures price.

In this scenario, the investor would simply take delivery of the commodity, receive $55 from the sale of the futures contract, store it for one month, and make a risk-free profit of $3 per contract. This strategy is known as cash-and-carry arbitrage.

In this example, it was made possible because the market did not accurately reflect the carrying charges of the commodity in the price of its one-month futures contract.

The Bottom Line

Investments cost money. But, it's not just the cost of the asset itself that you have to consider. There are also carrying charges associated with commodities and other financial securities. These costs depend on the type of asset you hold. Holding a tangible asset, such as a precious metal or commodity, comes with storage and other costs while assets like stocks and bonds usually come with a management fee. It's important to consider all the costs involved with buying and owning a financial asset before you make the plunge.