The Cost to Invest

Investing used to be a rich man’s reality and a poor man’s dream – but no more. With a few dollars and a little know-how, it’s possible for anyone to make their stock market dreams a reality. The cost to invest isn’t actually that high. That being said, you still have to know where to start.

Many individuals jump straight into researching their future investments, but just as importantly is how much you’ll need to get started. It’s one thing to want to purchase $1,000 worth of stocks your first go; it’s another to learn you’ll actually be spending closer to $1,100 after brokerage fees.

In this article, we’ll cover the cost to invest – as well as the true cost of some of your investments over time.

TL;DR

When you start investing, there are several types of fees to familiarize yourself with so as to not be caught off guard by the cost to invest. Depending on the type of investments you select, you may pay flat fees, commissions, per-trade charges, or an expense ratio on a whole account. Furthermore, you should watch out for not only exact dollar amounts, but differences in percentage fees on your account, as even 1% can add up to tens of thousands of dollars over your lifetime.

What are My Investment Options?

Before you know how much you’ll spend, you have to decide where you want to spend it. Depending on your goals and comfort zone, there are a few routes you can take to get started, each of which will affect your initial and lifetime costs in different ways.

Robo Advisors

Robo advisors are one way to invest without going it alone. This type of investment tool uses algorithms and AI to determine the best portfolio for your situation. These systems can even take into account financial goals, risk tolerance, and your investment time horizon to make the best possible decisions.

Often times, robo advisors will point you toward ETFs as your main investment vehicles. These typically have lower costs and are automatically diversified due to their makeup. (Diversification tends to bode well for your portfolio – which makes ETFs an obvious choice).

Robo advisors are “set it and forget it” methods, which means that you don’t have to stay on top of your investments more than you want to. These advisors are popular with both first-time and veteran investors, as they reduce risk and cost without compromising on quality.

In fact, due to lower fees, robo advisors can prove to be a wise investment for many as they carry much lower costs over a longer time horizon. Many robo advisors offer expense ratios (fees) as low as 0.25%, sometimes lower depending on how much you invest. This brings the cost to invest down.

Typically, these fees come out of the interest you earn before it’s paid out to you, so you don’t have to worry about scrounging up extra cash to cover the costs.

To get started with a robo advisor, you’ll need to decide how much money you want to spend. While many of these services require $500 or less to get started (your minimum deposit), some require upwards of $10,000 for your first investment.

Full-Service Brokers

Full-service brokers are the most expensive option when it comes to investing, which brings the cost to invest up. As a result, they typically only deal with high net worth clients, as some firms set their minimum deposit at $25,000 or higher. For this price, they offer a full range of services and financial advice, including:

  • Retirement accounts
  • Estate planning
  • Healthcare accounts
  • Trading in stocks, ETFs, and mutual funds
  • Exercising more exotic trading options (pun intended)

Usually, full-service brokers work by charging commission on your transactions in addition to charging a percent of the value of your assets. Some may also impose an annual fee equivalent to a membership charge.

Full-service brokers justify their higher expenses by hand-tailoring your accounts to your situation. However, this does not mean they’re the most cost-efficient, as their higher fees will cut substantially into your potential profits over time.

Discount Brokers

Discount brokers are the new normal for many who can’t afford the exorbitantly high fees of a full-service operation. These online brokers may allow you to make commission-free stock trades, though they’re likely require for more advanced financial transactions.

Some discount brokers have minimum deposit restrictions, ranging from $100 to $1,000 or more. These are usually quite low compared to full-service operations. Some accounts don’t require minimum deposits, but they make up their losses by charging other fees (everyone wants their money, after all).

Other brokers may lower their costs – such as trading and account management fees – if your balance rises above a threshold. This encourages you to invest more, which hopefully means that everyone makes more money in the long run.

However, with great freedom (and cheapness) comes great responsibility. For instance, you not only have to buy and sell on your own terms. But you also don’t have personalized advice from an expert. This means you have to do your own research and make selections based on your best judgement.

That being said, often times these brokers publish free educational materials for their investors. This can help you get started with all the tools you need to make (hopefully) wise decisions on your own.

So, What Does it Actually Cost to Invest?

As shown above, depending on which option you choose, fees may vary. Full-service brokers tend to charge 1-2% of a client’s managed assets. Some also charge various commissions and fees per transaction to cover the costs of trading. This can amount to hundreds of dollars in a single trade, depending on the worth – and amount – of the stocks.

And, though it may not seem it, that difference between 1% and 2% can make a big difference over time. (Don’t worry – we’ll cover an example in a minute).

For brokers who service smaller investors, there’s typically a small commission charge on every trade, both buying and selling. These fees range anywhere from $2 to $10 per trade with a discount broker.

Note that online brokers charge such fees per security. So, if you purchase ten shares of one stock, your broker will charge you for one trade. But, if you purchase one share of 10 stocks at once, your broker may slap you with 10 separate charges. (How rude!)

And, if you decide to sell these shares anytime soon, you’ll face a charge again for exiting your positions. (Double rude!) Therefore, if you trade frequently, you risk losing more of your investment than you earn in interest. Even if it doesn’t initially look like it.

Let’s break down some of these concepts with a couple of examples.

Example 1: The Difference 1% Makes

We said we’d cover the difference that 1% can make, and here it is! Let’s run through a couple of simulations with a mutual fund account.

The main difference between these accounts and brokers is that you pay a set fee called an expense ratio. This makes it easy to play around with our calculations for illustrative purposes. (Note that these are not the only fees that a mutual fund charges, but for the sake of example, we’ve kept it simple).

For both of these instances, we’re going to assume that you:

  • Have an initial investment of $1,000
  • Can contribute $1,000 per year for the next 30 years
  • Earn a 5% rate of return on your investment
  • Invest in a no-load, no transaction-fee fund

For the first simulation, we’ll use an incredibly low expense ratio of 0.05%. Under the circumstances outlined above, your net value (after fees) comes out to $73,392 and change. Overall, the total fees come out to just under $700 for the life of the account.

For the second simulation, we’ll go with a more modest expense ratio of 0.50%. Using the same parameters as before, your net value equates roughly $67,497 over 30 years, with $6,600 paid in fees.

For the third simulation, let’s take a much higher expense ratio of 1.5%. In 30 years, you’ll have amassed a net value of $56,236, with a total of $17,850 in fees throughout your investing career.

And, for our final simulation, let’s assume a rather extravagant expense ratio of 2.5% for the account. Over three decades, you’ll have earned $47,097 after fees – of which you’ll have paid almost $27,000 to the fund manager.

The chart below shows in stark detail how a few percent can eat away at your returns over time, even if the difference seems small in the interim.

Image Credit: Simulation run through Microsoft Word by Jordan Blansit

As you can see, from the first simulation to the fourth, we go from $700 to $27,000 in fees just by increasing the expense ratio a few percent. Whether or not it feels like it at the time, even half a percent makes an enormous impact on your financial health when viewed through a long-term lens.

Example 2: The Cost of Entering and Exiting Positions

So! You’re finally ready to invest. You know the exponential difference that 1% extra in fees can cost you. You’ve done your homework and selected your investments wisely (you hope).

It’s time to experience the real costs of investing your money in the stock market, rather than paper costs.

Let’s use the brief example from above and say that you decide to throw your first $1,000 into ten different securities with the best discount broker in town. Let’s also assume that because you chose a reputable broker, your commission per trade comes to $10.

Because you’ve decided to purchase one share of ten different securities, you’ve lost $100 of your investment on your first day – $10 per trade times ten trades. This means that your account is already reduced to $900 after costs, which comes to a 10% loss before you’ve had a chance to earn a penny.

In order to make up the difference, then, you’ll have to earn more than 10% on your investment in order to break even, let alone make a profit.

Now, let’s say that you keep your stocks for 90 days and see no change in price whatsoever. While you haven’t lost money in the market, you haven’t gained anything either. Rather than continuing to tie up your funds, you decide to pull your $900 out of the stock market. In doing so, you immediately incur another $100 in fees to your broker. (That $10 per-share cost is really starting to bite!)

Since your investments effectively didn’t earn any interest in the market, you’ve lost $200 through the normal process of entering and exiting your positions. Effectively, you have lowered your investment capital to $800 just by paying trading costs – a 20% loss of your initial deposit.

This example is one of many you can find on why day trading can be a highly costly and ineffective way to capitalize on your capital. It also shows why beginning traders should look to invest in securities with a higher probably of earning – and do so through trustworthy brokers with lower fees.

Types of Fees to Expect

Now that we’ve covered a couple of basic examples of the way fees can eat into your profits, let’s look at a few more fees to look out for in your investment journey. Unfortunately, there is no “one size fits all” answer to how much it will cost any particular person to invest. However, we can prepare you with a list of the fees you’re most likely to encounter as you begin your investment journey.

General Trading Fees

Minimum deposit: This amount is the bare minimum a broker will accept if you want to trade under their service. Depending on the broker, this fee can range from $0 to $10,000 or more.

Commission: Commission is a percentage taken off the top by the broker. Many brokers charge according to the total assets under management, while others may charge per new contribution. For a full-service broker, these charges average 1-2%.

Stock trade fee: These may be flat or share-based fees. Flat fees are more common; this means that your broker charges a single price regardless of which stock or how many shares you purchase. Share-based fees charge per share traded (this method is common with day trading brokers).

Broker-assisted trade fee: Brokers who operate over the phone often charge their own fees – note that this is not the same as a robo-advisor. These brokers usually work with clients who don’t have or want access to the internet or who want to deal in specialty shares.

Mutual Fund Fees

Mutual fund trade fees: Mutual funds may be traded online or via phone. Depending on the type of fund you plan to trade, you may have no trade fees on the condition that you keep the fund for a set amount of time. Others may charge commission or flat rate fees.

Note that mutual funds typically charge operating expenses, expressed as an expense ratio (such as in our example above). For instance, an expense ratio of 0.90% charges $9 per year for every $1,000 you invest, while an expense ratio of 1.5% costs $15 per year per $1,000 you invest.

Additionally, watch out for ongoing fees such as:

  • Front-end load fees: Investors pay these fees upon purchase of mutual fund shares
  • Back-end load fees: Brokers charge these fees when you cash out of your fund

Option Trading Fees

There are several fees associated with trading options. You may encounter:

  • Base fees: A flat rate per trade
  • Per-contract fees: These fees are typically structured as commissions on the whole contract, of which there may be several tiers
  • Exercise fees: Many online brokers charge a fee for exercising, rather than closing, your option(s)
  • Assignment fees: Assignment fees are typically charged to clients who have an option automatically bought or sold based on certain conditions

There are other fees as well based on the specific firm and conditions of the trade. Getting familiar with these most common fees is a good place to start.

Is It Possible for Me to Owe Money?

Believe it or not, it is possible to owe money to your brokers. Typically, you’ll sign paperwork to counteract such possibilities, but the conditions of such contracts may still allow for some loss.

This possibility primarily comes about via margin accounts, which is essentially a loan from your broker to cover part of your stock purchase. Often times, investors open a margin account to trade forex (foreign exchange markets) or in an attempt to short a stock.

If such an investment falls through – as in, the market moves in the opposite way an investor bet on – it’s possible for the investor to end up in a hole and owe money to the broker to cover the broker’s losses.

However, most brokers recommend or require that investors sign a stop order on margin accounts. This means that if an investment makes a significant move in the wrong direction, all shares of the security in question are automatically sold or returned to the lender.

While an investor in this situation may still end up owing some money to the broker to cover losses, a stop order will prevent the investor from losing their life savings on a bad call. These orders can also save investors if the market moves suddenly overnight while the investor is asleep. In this case, the potential for infinite losses and the reality of minimized losses are not the same thing.

So there you have it: The real cost to invest.

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