Your investment portfolio is influenced by many things which aren’t under your control. From the global economies, to national disasters, to surprise company decisions (e.g. Microsoft adding LinkedIn to their professional network), to political events (Presidential elections, Brexit) and even possibly the flapping of butterfly wings around the world. However one area where you do have some control are in managing trading or investing fees.
Investing fees for stocks
Since the rise of low-cost online brokerages, holding individual stocks is probably the cheapest way (*) to acquire and own investments for the long-term compared to index funds. That’s because there’s a one-time fee for the purchase and then nothing more. Depending on your brokerage and account status, even the one-time fee can be waived or reduced, so it pays to shop around and compare not only prices but benefits from total account value.
Typically though, most brokerages charge a $7 trading fee and so a $700 investment results in an actual spend of $707 with $7 going to the brokerage. In this example you’ve already ‘lost’ 1% of your investment so ideally you want to maximize the purchase and minimize the fee impact, say by purchasing $1,000 or more instead of $700 at a time.
You can also look for a brokerage offering lower investing fees. Interactive Brokers and Merrill Edge are two brokerages with access to lower fees which come to mind. Some of the newer investing startups such as loyal3 even offer zero investing fees. I’m not affiliated with (and have not used) any of those so please do your own research on which low-cost brokerage to use.
A lower than expected yield
Now suppose a stock worth $50 pays a 3% dividend yearly. If you buy 10 shares for $500 then you’ll get a dividend of 3% or $15 over the year. In reality of course, you paid $507 for that $15 dividend, so the actual yield is lower or 2.96%. And in money terms, the stock also has to increase in capital gains by 1.4% to break even.
Since the fee is a one-time ‘sunk’ cost, it’s largely ignored assuming that the purchase to fee ratio is fairly high. However it’s still there and its effect can add up over time if you’re making lots of small purchases with a commission.
Fees are also why I don’t compare portfolio performance to an actual Index such as the S&P 500 since the Index is a theoretical value only. If you must compare performance then compare it to something that can be actually be bought such as a low cost index fund. This also gives you a little advantage since it’s an easier result to beat than the Index itself.
(*) but not necessarily the best in terms of risk.
Investing fees for mutual funds
Mutual funds on the other hand have many ways to charge fees and they take their payment every day. There are some very cheap funds but very expensive funds exist too, so if you do own any, make sure you know what the fees are.
I was interested in comparing the costs of owning a fund vs individual stocks just to get an idea of the size of the investing fees involved. For this post, index fund means a commission-free and low cost (< 0.2% Expense Ratio). These funds are readily available from Vanguard or Fidelity – one good example is VTSAX which tracks the total US stock market at a very low 0.05% ER.
The Expense Ratio (ER) is the yearly amount that is taken from the fund’s net assets to pay for management and operational expenses. In reality, the amount is a fraction of that percentage taken every day from the fund’s share price.
The Expense Ratio drag
You can think of the ER as an anchor that’s slowing the fund down. Since index funds track an abstract Index with zero fees; they can never outperform their target Index simply because of the fees. This is the same as not being able to achieve the 3% yield for a stock purchase when you include the trading fee. The question for funds then is how much they under-perform their index due to their fees?
The diagram below shows the US Total Stock Market Index in green at the top; followed by the VTSAX fund (0.05% ER) in orange and finally below that, JETSX (John Hancock VIT Total Stock Market) (0.56% ER) in blue. They all start off together but over time they both get progressively lower because more of the total return is being siphoned off due to the higher fees, JETSX loses ground faster than VTSAX as time passes because of the higher ER.
Typically with a low-cost mutual fund, there’s no commission or purchase fee. So you pay $500 to own $500 (or whatever the minimum purchase amount of the fund is – all the way down to $1 for some funds). But the next day your $500 has really become $499.999 since it’s decreased by 1/250 of 0.05% (assuming 250 trading days in the market). The second day, it’s a little lower again and so on. It’s usually such a small amount that it’s not even apparent among the daily volatility of the market. Like trading fees for stocks, it’s not that noticeable, but it’s there just the same.
How much impact do investing fees have?
Investing starts with the accumulation phase which is where you are continually buying investments using income. At some point you retire and enter a withdrawal phase where your investments are providing your income.
But if you’re buying shares or investments monthly, just how much do investing fees affect things and are they even worth worrying about? To put things into perspective and compare the two approaches of continually buying shares monthly vs fund purchases, I made the calculator below to compare the two approaches.
Please keep in mind that comparing the performance of the two asset classes isn’t my intent here – the actual investment performance will be entirely different. I’m simply looking at the amount of fees generated over the accumulation period and their effect on the income received and total amount of investments purchased compared to having no fees. This information can help compare the effect of buying larger amounts of shares compared to smaller purchases for example.
My Fee Comparison Calculator
To keep things simple, the calculations represent a fictitious investment asset that has a static value whose price never goes up/down. It pays a 3% dividend, and it can be bought two ways: either as a stock with a trading commission; or commission-free as a fund but with an Expense Ratio.
You can enter the average monthly purchase amount, the trading fee for a stock purchase and the Expense Ratio of a fund for comparison. Finally the accumulation duration represents the number of years that the monthly purchases are made over.
The calculator gives an idea of the amount of investment purchased (monthly purchases plus re-invested dividends) i.e. the cost-basis that you would have. The actual market performance would vary greatly by the investments purchased and can’t be compared or predicted.
Reading the results
The default values above compare stock purchases at 1% commission with a fund at 0.16% ER over a 20-year accumulation period. The amount of income produced was almost the same ($120 difference in favor of the stock purchases). The total amount of the stock asset acquired was about $1,700 higher although the actual fees incurred by the fund purchases were twice as high. The stock purchases ended up with 0.7% more investments than the fund purchases at the end of the 20 years.
For stocks, the amount of investments purchased is always the amount of money spent less fees. For funds, the amount of investments purchased is always the amount of money spent since fees are paid indirectly from reduced market value.
The results will vary significantly based on the fee percentages and the duration that you pick. In general, the longer the duration the more advantage individual stocks have, because the stock fees become a progressively smaller percentage of the portfolio value over time whereas the fund’s fee is always fixed. But for really cheap funds (0.05% ER), it can take a long time for individual stock purchases to catch up.
The Withdrawal Phase
The start of the withdrawal phase is ideally when your investment portfolio is at its highest value and you’re not making as many new purchases. Yet fees are always being withdrawn from any mutual fund prices. Although this will be low in percentage terms it may be a lot in dollar terms because the portfolio value is high at the start of the withdrawal phase.
If you’re required to sell individual stocks in the withdrawal phase instead of entirely living off dividends then you may incur some fees but they will be significantly less than those from a fund. But holding individual stocks has higher risks than a diversified index fund so the underlying investment performance becomes more of a factor.
I decided not to include the withdrawal phase in the calculator. There are so many unknowns by the time that period is reached that I think there’s little information to learn from any estimation. In terms of living off dividend income and not needing to sell, then the real ‘cost’ of a fund is a slightly reduced dividend yield. For stocks there are zero to no fees.
My biggest portfolio holding is VHDYX which has a 0.16% ER. Assuming I had $2,000,000 worth in retirement, that would be $3,200 a year being siphoned off which is almost $14 of fees every trading day. Yet the $63,000 annual dividends I’d receive from that amount of investment have already paid that $3,200. Without any fees the fund would pay a 3.32% yield; the fees bring the yield down to 3.16%.
Like most things in life, you pay your money and make your choices. The real question about anything you pay for is “what do you get in return and is it valuable for you?”
In my case, I personally favor dividend-paying stock funds. The ones I chose are actively managed for higher yield and don’t track a passive index although they still have a low ER. It saves me time since they’re diversified, manage themselves and pay regular income. I’m willing to pay a small fee for that.
I also buy dividend growth stocks too, although I’m limiting the quantity to around 10% of the total portfolio size. My brokerage (Vanguard) charges a $2 fee and I currently plan for $600 minimum purchases for a fee ratio of about 0.3%.
Do you have a minimum stock purchase amount or own an expensive mutual fund?
Quote of the Day
Beware of little expenses. A small leak will sink a great ship.