How can I prevent commissions and fees from eating up my trading profits?
First off, understand that there is no universal system regarding trading commissions charged by brokerage firms. 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 might 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.
In these cases, the answer to this question actually has more to do with the amount of money you invest in each trade than it does with how often you trade. If, for example, you only have $1,000 to invest in a trade and you're using a discount broker that 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 that the round-trip cost of the trade is $40, or 4% of your initial cash amount. That means that 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 to this - 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 for customers who make 50 trades or more per month, they may only charge $10 per trade.
In other cases, an investor and his or her broker may agree to a fixed annual percentage fee (e.g. an annual fee of 2% of assets under management). In this case, it really does not matter how often you trade because you'll pay the same annual percentage fee.
To learn more about commission fees, read: How Brokerage Fees Work.
Glad you are asking this question. Minimizing commissions and fees can have a HUGE impact over the course of your entire investing career. Here are 3 ways:
- 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 ETF's. Read the fund's prospectus to know whether these fees are associated with any product you are investing in.
- Seek out ETF's with no trading fees. Many asset custodians charge between $7.95-$9.95 per trade, however, a growing number of fund families are waiving trading fees on their ETF's. As an example, Charles Schwab offers a full range of ETF's that have no trading fees.
- If you do decide to invest in a fund with a trading fee, try to invest over $1,000 per fund. To keep the math simple, let's say you are investing in a fund that charges $10 per trade. If you invest $1,000 in that fund, you will pay 1% ($10 out of the $1,000) for your initial investment and another 1% when you sell the fund for a total of 2%. However, if you are only investing $100 in the fund, you're paying the equivalent of 10% for the initial investment ($10 out of the $100) and another 10% when you sell for a total of 20%. You'll need to earn an awful lot of return to overcome those trading costs!
- If you decide to work with a financial advisor to help you with your investments, look for one who charges 1% or less of Assets Under Management for their services.
Thanks for the great question and good luck keeping those fees to a minimum so you can keep more of your money growing in your accounts on your behalf!
With Kind Regards,
Easy. Don't pay them.
You can invest in low cost exchange traded funds using platforms like Betterment, which charge no transaction fees. Fidelity, TD Ameritrade, or Schwab each have suites of transaction fees and ETFs.
If you are doing any of these things, stop buying individual stocks. Stop paying high fees for actively managed mutual funds. Stop short-term trading. They are all financial poison.
If you are an active trader, then you need a good discount brokerage firm. And there are two kinds of execution costs, explicit and implicit. Explicit are the obvious hard costs, the actual trade cost, or commission as you called it. But implicit costs are from bad execution. So if I went to the very cheapest brokerage firm for trades, but their execution was lost, did I save money? As an example, if trades at one brokerage firm were $6 versus $2 at the cheaper firm, but the execution price was $15 dollars higher, then in reality I lost $11. Sometimes you get what you pay for.
Iin fairness, execution prices have become much more competitive, as have brokerage fees. So your trading proficiency is much more important than transaction fees. Make sure you have a solid strategy and start small or even paper trade until you become confident the time and effort is worth it.
Best of luck, Dan Stewart CFA®
Cost comes hand in hand with frequent trading, whether it is commissions or the spread between the bid and ask. Getting your costs under control is something that needs to happen before you begin implementing a strategy. This can be done by reviewing many brokerage relationships, and understanding the difference between best commission cost and best execution for your planned transactions, as all transactions are not created equal.
If you have done your homework, and the cost remains too high for the trading strategy to work, find another strategy.