Costs And Fees Associated With Investments
What follows is a brief description of the various costs and fees that investors incur, be it due to transactions or an ongoing relationship.
- Commission: this fee is expressed as a percentage of the product sold. When an investor buys or sells shares or bonds that are exchange-traded, he or she pays a commission expressed in dollar or percentage terms to a broker. In a mutual fund, the fund pays the commission.
- Markup: for shares and bonds that trade over-the-counter (OTC), a market maker (essentially a middle man or jobber) buys shares from and sells share to investors, earning a markup or spread for his or her efforts. The design is to maintain an orderly market, but some bid-ask spreads are wider than others, to reflect a lack of demand or marketability that may stem from difficulties in valuing a particular security or product
- Broker's Call Loan: when engaging in short sales or making purchases on margin, the investor borrows funds that charge an interest rate which must be disclosed.
- Asset Management Fee:
- Mutual Funds charge a percentage of assets to manage a fund. The percentage rate or expense ratio is often a function of the risk level and trading activity associated with the investment being managed. As an example, a small capitalization growth mutual fund would, all else equal, have a higher asset management fee than a large capitalization value fund, where the portfolio manager or management team would patiently look for undervalued stocks that they would buy and hold in accordance with the fund's buy discipline. An important distinction with asset management fees that apply to mutual funds is that between active and passive management. An actively managed fund entails purchases and sales to satisfy the fund's objective; a passively managed or index fund seeks to replicate a specific segment of the financial markets (e.g., medium duration bonds or large capitalization core stocks, such as those in the Standard & Poor's 500 Index), holding, rather than trading, the assets which results in a lower fee. The premise of passive investment management is that markets are in the main efficient and that precisely because of the research and trading activities of active managers, no significant returns beyond what the market as a whole yields may be achieved over the long term.
- Investment Advisors and Financial Planners enter into relationships with their clients on a fee only basis. This means that they charge the client or place the client's money with (a) third party managers (separate account or structured portfolio of mutual funds) that charge the client a percentage of his or her assets under management, typically on a sliding scale where the percentage decrease at certain asset thresholds. In this example, the advisor or planner does not collect any fees from trading individual securities. Some advisors and planners "wear two hats," as it were, working on a fee basis, but also collecting, rather than offsetting, a commission where a product implementation (purchase) may be warranted
- LBOs: in addition to the annual management and incentive fees, the buyout firm may charge to the corporation that it has helped to take private, a fee of up to 1% of the company's total selling price for the arrangement and negotiation of the transaction.
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