You work hard for your money. And you should be able to keep as much of it in your pocket as possible. But if you're thinking of investing your hard-earned cash to increase your net worth, there are some things you should keep in mind. Investing comes at a cost. There's certainly risk involved which can eat away at your profits. But something else that can chip away at your bottom line is the cost—from fees to commissions. And it can all add up. So can you actually put your money away and keep your expenses low? The short answer is yes. Read on to find out more about how to keep these costs from depleting your profits.
- Investment expenses include brokerage fees, commissions, and management and advisory fees.
- Commissions and fees aren't universal—they vary from firm to firm.
- Keep your expenses down by investing with a no-fee brokerage firm or trading house.
- Robo-advisors use algorithms to manage portfolios, so they may come with low or no fees.
Types of Investment Fees
Most investments come with some type of fee. It's one of the only ways banks and other firms can make money. By charging you a fee, these institutions can keep running and offer you their services. Even the simplest investment vehicle comes with some form of service charge. Most savings accounts, for instance, charge a fee if you don't keep a minimum balance and you will incur a service charge if you make more than one withdrawal a month. It's your money, so why do you get hit with a fee? The account is, after all, meant for you to save your money.
This principle—of charging a fee—is pretty consistent across the board. Businesses charge you money in order to keep and handle your accounts. But they also do the same when you want to move your money around. At times, you may feel like you're paying more than you're investing. Surely, there must be a way to keep that to a minimum, right? Of course, there is. But before we outline how you can keep your money in your account by not paying outrageous fees, here's a quick look at some of the most common expenses that come with investing.
A brokerage fee is charged by many different financial services companies including brokerage firms, real estate houses, and financial institutions. This fee is normally charged annually to maintain client accounts, pay for any research and/or subscriptions, or to access any investment platforms. These fees may also cover instances if and when an account goes dormant. Brokerage fees may be a certain percentage of the balance held in a client's account or a flat fee.
Brokers and investment advisors often charge clients commissions for using their services. These are also called trading fees. They basically pay for any investment advice or to execute orders on the sale or purchase of securities including stocks. commodities, options, or exchange-traded funds (ETFs). Commission charges vary from firm to firm, so it's important to verify a brokerage's fee schedule before you decide to use their services.
Management or Advisory Fees
Management or advisory fees are charged by companies that run investment funds. Fund managers are compensated with these fees for their expertise. Although they can vary between funds, most of these fees are based on a percentage of the assets under management (AUM) in each fund.
The Basics of Trading Expenses
There is no universal system regarding trading commissions or other fees charged by brokerage firms and other investment houses. Some charge rather steep fees for each trade, while others charge very little, depending on the level of service they provide. A discount brokerage firm may charge as little as $10 for a common stock trade or even less, while a full-service broker might easily charge $100 or more per trade.
Fees vary from firm to firm—some fees are very steep, while others are fairly cheap.
So how much you pay actually has more to do with the amount of money you invest in each trade rather than how often you trade. If you only have $1,000 to invest in a trade and you're using a discount broker who charges $20 per trade, 2% of the value of your trade is eaten away by the commission fee when you first enter your position. When you eventually decide to close out of your trade, you will likely pay another $20 commission fee, which means the round-trip cost of the trade is $40, or 4% of your initial cash amount. That means you will need to earn at least a 4% return on your trade before you break even and can begin to make a profit.
With this type of fee structure, which is quite common, it really does not matter how often you trade. All that matters is that your trades make enough of a percentage gain to cover the costs of your commission fees. However, there is one caveat—some brokerage firms give commission discounts to investors who make many trades. For example, a brokerage firm may charge $20 per trade for its regular customers, but may only charge $10 per trade tor customers who make 50 trades or more per month.
In other cases, investors and brokers may agree to a fixed annual percentage fee. Because you pay the same annual percentage fee, it doesn't really matter how often you trade.
Keep Your Expenses Down
Even though fees are an integral part of the financial system, you don't have to be beholden to them. There is a way that you can keep your expenses down and continue investing.
Consider investing your money with a firm that charges no commissions or fees for stock and ETF trades. More firms—especially small companies and those that are new to the game—are adopting this structure to attract and retain clients. Some of these firms also waive the minimum deposit requirement, so you can start off with a low balance at no additional cost. You will, however, want to check on their fee structure for other investment vehicles along with any other fees they may charge to see if it balances out.
Automated investment platforms may also help cut down on your expenses. Robo-advisors are a relatively new trend in the financial industry and can be great for small investors because they're free. This means more money in your pocket. They can afford to do this because they're automated, so they don't have anyone physically managing client accounts. Instead, robo-advisors use algorithms to maintain and reallocate your holdings according to your risk tolerance and investment goals.
Dave Rowan, CFP®
Rowan Financial LLC, Bethlehem, PA
Minimizing commissions and fees can have a huge impact on your investing career. Here are three ways to do so:
- Invest in exchange-traded funds (ETFs) rather than mutual funds. The expense ratios are almost always lower for an ETF versus a comparable mutual fund. It is now very easy to build a low cost, well-diversified portfolio using ETFs with an expense ratio of 0.25% or less per year.
- Avoid products with front-end loads, back-end loads or 12b-1 fees. These are typically found within mutual funds, but not ETFs.
- Seek out ETFs with no trading fees. A growing number of fund families are waiving trading fees on their ETFs.
If you do decide to invest in a fund with a trading fee, try to invest more than $1,000 per fund.