John C. Bogle is the founder of Vanguard Investments and is one of the biggest proponents of low-cost investing. In his estimation, investors as a whole pay between 3 and 3.5% in costs on their investments. This collectively goes to the investment profession in terms of trading commissions, management fees and other charges that advisors and brokers charge for providing advice to their clients. (For related reading, also check out Earn More Profit With Less Trading.)
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In an environment of low interest rates and flat stock market returns, this is a big deal. Historically, stocks have offered the best returns, posting annual returns of roughly 10% since 1928. If you subtract inflation, real returns have been a couple of percent lower, and subtracting investment costs means most investors are lucky to gain anything in real terms on their investments, which is true even in a normal market environment when yields are higher and stocks post positive returns.
With that, here are five key ways to lower costs on your investments.
Warren Buffett has stated that, for the majority of investors, indexing is the best way to invest. His mentor, Benjamin Graham, divided investors into two camps. The first are enterprising investors that have the time and energy to devote to searching for investments that have a good chance of outperforming the market. The second are defensive investors that have no time or interest in investing.
These investors could look to hire a broker or investment manager, but given the majority underperform the market over time, it makes sense to save by buying a low-cost index fund and not have to pay them a management fee that can easily cost 1% of assets under management or more. Bogle is also a big proponent of index funds and Vanguard was one of the pioneers in offering them to individual investors. In his estimation, index funds charge only about 20 basis points, in terms of total expense ratios.
This is especially important when it comes to investing in bonds. Interest rates are at historical lows so investment costs can easily eat up the majority of fixed income returns. Low-cost bond index funds can help, as can buying individual bonds and holding them to maturity.
Low-Cost Mutual Funds
Index funds are some of the lowest cost mutual funds in the market. Exchange traded funds (ETFs) are generally also very low cost and have other tax advantages, though it is important to note they are not mutual funds and have other characteristics that will need further investigating. For investors interested in looking to actively-managed mutual funds, it pays to keep the management fee as low as possible. One percent or lower is a good rule of thumb.
It used to be that the only way to open and maintain an investment account was by using full-service brokers. Annual account maintenance fees were common and still exist for more affordable discount brokers. There should be no reason to pay maintenance fees. Even if they are low at $10 to $15 annually, a broker is getting a benefit for using your money, including through securities lending and other activities that let the brokerage firm earn a higher return on your cash than the interest they are paying you.
Again, certain individuals may find it more convenient to completely outsource the managing of their assets to an individual, but those that are more keen on saving money will find that it doesn't take much effort to find low-cost ways to maintain investment accounts. A primary way to do this is to avoid full-service brokers. (To learn more about choosing a broker, see Brokers And Online Trading: Full Service Or Discount?)
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As with unnecessary account fees, full-service brokers generally charged $50 per trade or more, depending on the number of shares traded. Brokers used to also get paid per trade, so the incentive was to buy and sell stocks or bonds as much as possible. These days, an online broker charges a fraction of the cost of a full-service one. It is very easy to find stock trades for less than $10, and therefore the bite that trading costs can subtract out of an account's value over time.
On a related aside, always read the fine print in your accounts to see if there are any other hidden commissions or fees. I knew of one firm that charged next to nothing for trading commissions but offset this benefit by paying well below money market interest rates for cash held in client accounts.
Buy-and-hold investing has received a fair amount of criticism over the past decade. This is certainly warranted given stock returns overall are roughly flat over this time frame. However, many stocks have performed well and those that don't trade often have the opportunity to maintain profits in the form of unrealized gains. Not realizing gains saves on capital gains taxes and also keeps brokerage commissions to a minimum. This is obviously not possible in retirement or other tax-advantaged accounts, but it can save a substantial amount of tax expense in taxable accounts.
The above represent some straightforward ways to keep investment costs at a minimum. Investment gains are still important and the future should be less of an uphill battle as interest rates should rise and stock market returns are generally stronger after struggling over a ten-year period. Investors can further their chance for positive overall returns by keeping a close eye on investment expenses.
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