Investors often forget to factor in trading costs when choosing funds, brokers and trading strategies. Trading costs matter and can be the difference between out performance and under performance.
In mutual funds it is important to look at the portfolio turnover per year. Some funds turn over their holdings more than 2 times per year (200% turnover). I prefer funds that have almost no turnover. While you are not charged directly for the cost of trading, it is a factor in the expenses the fund subtracts before calculating your return.
If you trade frequently, you absorb lots of trading fees. Say for example you want to buy 100 shares of a $10 company and it costs you $20 per trade. You spend $1,000 on the stock and $20 on the trade or 2%. You will spend another 2% when you unwind the trade. So, you have to have a return of at least 4% on the trade just to break even. For smaller investment amounts, the percentage impact can be even bigger. And if you trade frequently, you are generally trying for small profits per trade. It is a big bogey to get over.
As for brokers, most brokers now offer online trading. And the cost of online trading is falling quickly. The impact of this is to enhance your portfolio returns and make investing smaller amounts practical and feasible.
According to The Wall Street Journal 11 July 2006 p. D1the cost per trade for small investors averages around $13 or $14 per trade and for large investors or frequent traders the cost has fallen to under $10 per trade. There are some firms that are even cheaper or that specialize in small investors so it is worth doing your homework before you choose a broker.
Good luck and good investing. Also, push one or more of the links below to subscribe or register your feelings about the post. I'll be glad you did!
You are absolutely correct. Trading costs add up extremely fast, and for investors that prefer dollar cost averaging, paying commissions will eat away your returns before you even have a chance to realize them.
For investors with a long term horizon (8+ years), nothing can beat the efficiency of index funds.
"Over the 35-year period from 1971 to 2004, the average annual return on all actively managed equity mutual funds trailed the S&P 500 Index by 87 basis points a year, and the broader-based Wilshire 5000 Index by 105 basis points a year. Over long periods, this difference in return amounted to substantial differences in wealth." -- Yahoo! Finance article
However, if you are going to invest a large lump sums of money, ETF indices may be the way to go. Lower overall expenses, and you usually pay one commission charge, regardless of the amount of shares traded.
Posted by: Jason | July 11, 2006 5:12 PM | Permalink to Comment