Transaction costs are the bane of investors everywhere. Whether the market is up or having its worst day ever someone makes money; that someone is the Stock Broker.
Consider the following fees charged by the following firms for trading stocks:
|E Trade||$7.99 – $9.99|
Here Comes the Math
On the surface these fees may not seem like an excessive amount, but looking at it from the perspective of a new or small investor changes things a bit. For example, our new investor (let’s call him Mr. Value) has just saved enough to open his first brokerage account…a hard earned, hard to come by $1000. After long hours and study, Mr. Value has found the perfect first pick for his portfolio. Grabbing a “Dow 30” component for around $8.35 a share he makes his purchase. Not wanting to put all his eggs in one basket he opts to go with 75 shares, because he’s sure of his pick and round numbers are easier for math.
So, 75 x $8.35 = $626.25 + the 7.00 fee (which is 1.11% of the cost) will total $633.25 or $8.44 a share.
It’ll be another $7.00 to sell those 75 shares. $633.25 + $7.00 = $640.25 or 8.54 a share.
Just to break even Mr. Value’s investment has to grow 2.28%.
Mr. Value hopes his investments will grow at around 8% a year. The first year he hits that mark, minus the 2.28% fees and 3.24% average inflation leaves him a net of 2.48%. Even if we exclude the sell side since Mr. Value holds long term, he is at 3.64% if things go according to plan.
How to Beat the ‘House’ at its Own Game
Wikipedia defines a stock broker as, “a regulated professional broker who buys and sells shares and other securities through market makers or Agency Only Firms.”
Professionals get paid when their services are utilized. So I suggest the following methods to keep transaction cost at a minimum:
- Buy in volume – After first opening a brokerage account it is tempting to start investing right away. I suggest waiting until an adequate cash reserve is built up so that buying in volume dilutes the cost of your purchase and subsequent sale.
- Inactivity – Buy and hold will minimize transaction cost. Purchases made with a margin of value are perfect candidates for lifetime holding. Also, this can help reduce possible tax cost, but that is another topic.
- Company purchase plans – Some employers still offer a direct purchase plan for employees. If you work for a solid company this may be a viable option to get stocks and circumvent the brokerage fee altogether.
No and Steady Wins the Race
“Our favorite holding period is forever.” – Warren Buffett
By its nature Value Investing should lend itself to lower transaction fees. Waiting for that fundamentally sound company at a fair price or less may take a while. When that fat pitch presents itself a purchase can be made in volume and held long term to minimize transaction cost and taxable gains.
It is my goal to go transaction free for one year from today. This commitment locks me into my current portfolio and helps remove the temptation to sell or purchase. I will continue to look for companies that meet my requirements for investment. If I find one worthy of purchase this will be another fail safe to bounce it off of: “Is this company, at this price worth not achieving my no-transaction goal?”