Understanding costs and how to control them

The enemy of wealth is cost. Markets rise and fall. Taxes structures change. Inflation ebbs and flows. However, costs, fees, and expense ratios always remain. Smart investors can beat this problem.

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Why costs matter

Too many investors have been trained to ignore costs because they’re designed to look minuscule. The average expense ratio for an equity mutual fund is 0.70%. This number represents the total that removed from the fund’s assets. At less than a percent many investors cast aside this burden as a small but necessary evil. In truth, there is nothing small about 70 basis points. A $10,000 investment over 15 years at 7% will rob you of $2,586 in fees.This loss is only the beginning.

Consider the opportunity cost. If you invested the total fees of $2,586 under the same assumptions, the total would grow to $5,571. When you pay fees you lose twice: First, when you pay them and second when you miss out on what the money could have done for you. Even simplified target date funds carry an average expense ratio of 0.57%.

Start at zero and stay there

Brokerage firms and investment companies have grown increasingly competitive in recent years. As a result fees across the board have dropped. Morningstar reported, “Over the past five years, 63% of the fund share classes and exchange-traded products in our universe reduced their expense ratio, but only about 24% of them saw their fee fall by more than 10%.” Fees are falling but not far enough and not fast enough.

However, technology has driven these fees even lower, and today it’s possible to trade U.S. equities free of charge. FinTech companies like Robinhood have leveraged efficiencies to help the investor get in the game for nothing; U.S. equities carry no fees. If you plan to trade, foreign securities consider TradeKing, which offers trades for a flat $4.95.

Avoid complex instruments

More complex instruments like derivatives and options often carry greater costs. These products are rarely of much use to the ordinary investors; they carry increased risk, and generating gains is difficult, as you must earn back the costs plus more.

Even more expensive are margin accounts, which allow the user to borrow money against the value of their account. This behaviour is dangerous as a margin call can erase your holding in a steep market decline. By keeping the trades simple the cost structure will be easy to understand and lower.

Don’t let costs influence strategy

When you reduce or eliminate costs, you avoid the problem of letting fees influence your trading. Much of the insider and hedge fund trading reported on KINFO reflects new trades. If an investor wants to match these movements, they may become a more active trader than they expected. In a high-cost environment, painful fees can slow or even halt trading momentum.

Start by choosing a broker that offers the lowest fees for your trading style. If you plan to mimic the trading of the data shared on KINFO, remain cognizant of how important low fees are. As Burton Malkiel once remarked, “You can’t control the market but you can control what you pay.”

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