The rising popularity of mutual funds and low-cost exchange traded funds have made it easier for smaller investors to put less funds into pooled investments that let them act more like big investors. However, in certain respects, they are still at a disadvantage compared to bigger, deep-pocketed investors. A key component of the advantage big investors have over smaller ones is the ability to save on fees and related investments costs, which they are able to spread over a larger asset base and lower average costs. Below are three types of fees and costs that big investors can save on, giving them a big advantage over the smaller investor. (For related reading, also check out Don't Let Brokerage Fees Undermine Your Returns.)
TUTORIAL: Stock Basics
When seeking outside investment expertise, investors with higher initial balances can almost always negotiate more reasonable expense ratios. The cut off is usually around $1 million, with balances below this amount charged an average annual management fee around 1%. Bank trust departments, brokers, and asset managers will generally lower management fees the higher the amounts invested. The fees are usually lowered by 10 basis points (one hundredth of a percentage point) to 25 basis points for each additional million invested. With between $5 million and $10 million, big investors can pretty easily get an average management fee below 50 basis points.
Higher initial balances can also carry additional benefits. Asset managers may generally be willing to eliminate any annual account maintenance fees. This also applies to 401(k) plans where higher overall balances can result in fee breaks and means plans offered by larger companies can be more cost effective than identical ones offered by smaller ones.
Buying and selling bonds in larger amounts is usually more affordable and again favors big investors. When a bond trades in the secondary market, there isn't an explicit trade commission like there is for buying or selling a stock. The cost to the investor is instead built into the bid-ask spread, which is the difference in price a broker is willing to buy a bond from the price it is willing to sell the bond.
A broker will sell the bond at a higher price it bought it at to lock in a profit, or commission. Larger blocks usually have smaller bid-ask spreads, which is because the broker is still earning a higher overall commission with the smaller spread. The smaller the bond transaction, the higher the bid-ask spread is likely to be. In general, high bid-ask spreads can be between 4% and 5%. Odd-lot bond positions can be the most costly and generally occur for bonds less than $15,000, which is what smaller investors are usually most likely to prefer, given the lower account balances. For portfolios below $50,000, it is usually extremely difficult to build a cost-effective bond portfolio. (For more on bonds, see The Advantages Of Bonds.)
TUTORIAL: Brokers and Online Trading
The Performance Fee
Though not an explicit fee, a lack of performance can mean that an investor's portfolio misses out on gains. Large investors that meet the definition of an accredited investor, or a person with a net worth of around $1 million or annual net income greater than $200,000 (or $300,000 including a spouse), can have access to investments that aren't allowed for non-accredited investors.
This includes hedge funds, venture capital funds, and other investments including private equity. The current craze with investing in social media firms is currently reserved for accredited investors and means smaller investors could potentially lose out if they end up making big returns. On the flip side, investment performance is not guaranteed and many strategies available to big investors don't turn out as anticipated. However, a larger universe set does offer the potential for bigger returns for large investors. (For related reading, take a look at Hedge Funds Go Retail.)
The Bottom Line
In general, greater account balances allow underlying, bigger investors to spread investment costs over a larger asset base and therefore lower the average fee. This applies to investment management fees as well as to buying and selling bigger blocks of securities. Perhaps the biggest potential benefit that larger investors have is the opportunity to invest in supposedly more sophisticated assets, such as hedge funds, private equity and venture capital investments. This isn't a fee, but the special access can mean better performance that, like lower fees, can lead to even higher account balances at the end of the day.
Disclosure: At the time of writing Ryan C. Fuhrmann did not own shares in any company mentioned in this article.