When I finally started making enough money to invest beyond my 401K or emergency savings account, I was so excited to get started that I committed the cardinal sin of novice investors: I succumbed to transaction fees.
There I was, knowing darn well that transaction fees can seriously erode the value of your investment – but doing it, anyhow. Call it laziness, willful ignorance, or the hazy hope that somehow the rules of investing simply didn’t apply to me. Anyway you cut it, I was shooting myself in the foot every time I clicked the “trade” button and another $7 went out the window.
Investing Fees Hurt More Than You Think
If you think I’m over-reacting, bear with me for a second here as I demonstrate a simple example. Let’s say I invested $100 in stock of ABC company, paying $7 in transaction costs. That would mean the value of the stock would need to rise 7% just to cover the transaction fee. Ouch.
I was so eager to invest my money in the market, that after every paycheck I’d do it again, and end up paying too much just for the sake of buying stock or ETFs. After all, $7 here or there didn’t seem like that much money.
But my poor little investment account was suffering under the burden of transaction costs. And I wondered why I wasn’t seeing the numbers grow more significantly.
401Ks Suffer, Too
This problem isn’t limited to online brokerages or individual investment accounts, either — 401Ks, mutual funds and many other investments carry fees, as well. MSN Money created a chart demonstrating how the simple “little” one or two percent fees many of us pay on 401Ks, for example, can seriously damage your future wealth.
For example, a worker investing $5k per year for 40 years into their 401K would have over $878,000 if their fees were 0.5%, but only $475,000 if they paid 3% fees.
The first thought that came to mind when I realized how much my investments were struggling against transaction fees was to invest less often, so that I’d have fewer transactions, and save on fees.
But that’s not a good solution, because I knew that the time value of money was important — that the sooner I invested my money, the faster it’d grow. Plus, I wanted to invest regularly and “pay myself first”.
So, I started searching for online brokerages with lower costs, and what I found surprised me:
First, trading on many ETFs is free, depending upon the broker. Charles Schwab, TD Ameritrade, and Fidelity, amongst others offer free trades on several of their most popular ETFs. They’re a good alternative to index mutual funds (such as funds that track the entire stock market, or particular sectors therein).
Mutual fund trades can also be had for free, but usually only when it’s the online broker’s own fund. The benefit of this, however, is that it also makes automatic investing possible. For example, you can set up an automatic investing account with Vanguard to invest regularly in Vanguard mutual funds, thereby helping you remove a barrier to investing.
Read the Fine Print
While these are great ways to eliminate or significantly reduce the burden of transaction fees on your investments, they do come with a few caveats. You should be aware that in many cases, you’ll be limited to a certain number of transactions per month, making it difficult for you to actively trade or change your positions frequently.
You’ll also need to take note of other fees and expenses – such as any administrative costs or processing fees. Fees are fees and they can all eat into your investments.
Finally, you should be aware that not every ETF or mutual fund may be available commission-free — and that this may be used to entice you to purchase funds that do carry fees. It’s possible to construct a well-diversified portfolio on commission-free funds, alone, but it’ll take a little research(more on this later).
Still, I’ve saved hundreds of dollars in fees and taken some of the weight off my investment account. It’s now climbing the financial returns hill a little more quickly.
Have you had success with no-commission funds and trades? Share your experience below!