Your investments are impacted by frictional expenses that are basically costing you money. If you are able to lower your expenses, you are able to increase your long-term rate of return through lowering your overall cost basis.
The most common and encountered frictional expense is brokerage commissions and fees. Discount brokers have significantly reduced the cost of buying and selling over the past few decades. For example, by calling and having a broker execute a trade, an investor could expect to pay $31 plus 1.50% of the principal value of the investment on a trade of $2,500 on 1,000 shares of stock. The investor pays $68.50 in fees. If the investor places the order online, he may only pay a commission of $29.95. The cost has been reduced by 50%. Same trade, same bank, just a lower fee.
Look at this in a bigger way. If there was a dollar cost averaging plan in effect, the additional commission expense would add up to $462.60 annually. If you consider the long-term appreciation rate of 12% on the investment, over the next 40 years, the added commission cost would add up to $354,856 in lost wealth.
Asset management fees can cost you even more over the long term. Many companies will charge fees of 1.5% of assets. A family with $10 million of net worth would pay $150,000 a year in fees - even if their investments lose money.
In addition to the fees associated with trading stock, you need to be aware of the capital gains tax. You are in control because you get to decide when the tax bill will come due. Each year that goes by without selling your appreciated securities, the value of the deferred taxes increases.
The frictional expenses of mutual funds, including management fees and sales loads, are the reason that actively managed funds have not outperformed non-managed counterparts such as index funds. In order for an actively managed fund to break even with the market, it would have to earn several percentage points higher in returns in order to pay the associated frictional expenses. Index funds are usually a group of non-managed stocks that rarely change, therefore they don't require the frequent sale of securities and the additional costs associated.
When looking at your portfolio and investment decisions, you can't just focus on the gains. You must look at how the frictional expenses will affect your investments over the long term. Know exactly what your trading costs you. You may find that you need to change some of your strategies or investment methods. Don't let the frictional expenses cost you wealth. Mitigate your costs and take control of your potential earnings.
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