In this article, you will learn:
How do brokerage commissions and fund management costs affect my investment returns?
In the United States, by law, individuals must go through a FINRA registered stock broker to buy and sell stocks. This is important because stock brokers act as intermediaries between investors and stock exchanges, making sure orders are executed in a matter of seconds while still complying with the various securities and trading laws as set forth by SEC.
However, there are brokerage commissions associated with trading through a broker. Retail brokers, who work for individual investors, usually charge around $6 to $10 per online trade, with other associated fees and commissions for anything other than basic stock trades. Trades over the phone or through full service brokers, who also provide advice, can easily top $50 to $100 per trade. Therefore, online brokers make much more sense than full service brokers for educated investors.
Managed funds, including mutual funds, which manage investor's money and promise superior investment returns, require hefty management fees which average around 1.3% to 1.5% of invested funds per year.
These fees may sound small, but through the effect of compounding returns, these commissions and fees quickly eat into your long term investment returns. Let's say you invest $10,000 over a 40 year investing timeline and achieve investment returns of 10% a year over that period. Below is a chart comparing the value of this investment at the end of those 40 years with zero costs, 1% costs and 2% costs. With zero costs, our invested wealth rises to $452,593, compared to $314,094 after 1% costs, and just $217,245 after 2% costs. By minimizing costs, it is possible to nearly double investment returns after compounding, which is a staggering result.
Obviously, trading costs are an inescapable part of investing your money in any sort of asset -- real estate agents, who are in the business of brokering real estate transactions, regularly take a 6% to 7% cut of the sell price of homes, and compared to those kinds of fees, stock brokerage costs almost seem cheap. What's important to know is that these brokerage costs are real and knowing how to minimize these costs is a necessary and valuable skill.