Online brokers aggressively advertise their low commission rates, but consumers need to recognize that those commissions are just one way brokers make customers pay for their accounts. Savvy consumers can save themselves a significant amount of money by avoiding, or at least minimizing, a variety of different fees and charges associated with online brokerage accounts.
Cost control is an important element of investing. Face it, you can't control what stocks or bonds are going to do. But you can at least keep a firm grip on the cost of investing. Those costs are a hurdle your investment returns have to clear before starting to make money, so minimizing cost is one way to enhance your net returns.
The following is a guide for controlling online brokerage costs:
Shop Around for the Lowest Commission
A recent MoneyRates.com study for the Best Online Brokers found the average online brokerage commission was $6.05 per trade. However, the amounts different brokers charge are all over the map. Flat-rate commissions range from $2.50 per trade to $19.95, so some customers are paying nearly eight times as much for trading as others.
While commissions are not the only factor in choosing an online broker, you should at least do some comparison shopping in an effort to end up closer to the bottom of that commission range than the top.
Know Your Trading Needs and Investment Patterns
The cost of a particular broker does not just depend on the fee schedule - it also depends on how you use that broker's services. Think about how you are likely to trade. When doing your comparison shopping, you can base those comparisons on what you would be charged based on your account activity.
For example, if you plan to use margin regularly, a comparison of margin interest rates might be every bit as important to you as comparing commission rates.
If you tend to be a high-frequency trader, you might benefit from looking for a broker that offers specially-discounted commission rates for customers who exceed a given trading volume. However, don't ramp up your activity just to qualify for those discounts - this would be a false economy because too much trading tends to be an inefficient way to invest.
Check for Maintenance/Inactivity Fees
Watch out for brokers that charge a monthly maintenance fee, or a fee for months where you don't generate a required number of trades. Most online brokers do not charge these fees. But for those that do this, the added fixed cost can take a meaningful chunk out of your account over the course of a year.
When these fees are charged, they tend to be assessed as fixed dollar amounts rather than as a percentage of the portfolio's value. As a result, they can represent disproportionately large pieces of small accounts, so investors who don't have a large sum of money to invest should be especially careful about avoiding these fees.
Avoid Tiny Trades
Diversification - owning a wide variety of securities in your portfolio to spread out your risk - is important. However, it can also create cost inefficiencies for smaller investors.
Because most commissions these days are quoted on a flat-rate, per-trade basis, the smaller the dollar value of the trade, the greater portion of that value the commission represents. For example, the average commission of $6.05 represents just 0.06 percent of a $10,000 trade - a negligible amount. However, that same commission would represent 1.21 percent of a $500 trade, which could meaningfully erode your return.
These trading costs take on added importance because you will pay a commission both when you buy and when you sell a stock, so the round-trip trading costs are essentially twice the commission rate. Smaller investors may want to try a more concentrated investment style to help cut down on commissions. This means owning fewer securities representing greater portions of the portfolio.
If you would rather take a more diversified approach, exchange-traded funds (ETFs) can be a cost-effective way of achieving that goal. These funds comprise many securities representing a designated segment of the market, allowing you to obtain broad diversification in a single trade.
Buy and Hold Investments
The easy access of online stock trading has encouraged day-trading and other high-turnover techniques. It's crucial to remember that these are often inefficient because they rack up a high volume of brokerage commissions. Keep in mind that investors like Warren Buffett have gotten rich by making long-term commitments to their investments, not by jumping in and out of them with great frequency.
A buy-and-hold approach is more conducive to fundamental analysis as opposed to simple market speculation, and it can meaningfully cut down on commissions.
Consider two investors who each own 30 stocks in their portfolios. One is a buy-and-hold investor who turns over his portfolio on an average of once a year, while the other is a short-term trader who turns his portfolio on an average of once a month.
That buy-and-hold investor would pay about $363 a year in brokerage commissions. The short-term trader? His or her commission bill would add up to $4,356 over the course of a year. It is very difficult for your investments to come out ahead when you are paying so much extra in commissions.
Consolidate Transfer Activity
Most online stock brokers will charge you a fee for every transfer in and out of the account. Make sure you know what transfer fees your broker charges, and adjust your activity accordingly.
For example, don't treat your brokerage account like a checking account because frequent transfers of cash in and out of the account could be costly. Also, when it comes time to change brokers, consider liquidating your account holdings so you can make one consolidated transfer out of the account, rather than racking up multiple fees for several individual security transfers.
The one caveat is be sure to consider the tax consequences of liquidating your holdings all at once. In an effort to attract new customers, some online brokers offer to reimburse transfer fees for incoming accounts. Finding a broker offering this sort of deal might be the best option if you have large taxable gains that you would rather not incur right now.
With respect to all types of online brokerage account fees, be sure to monitor your account closely so you can keep track of what you pay in fees. Also, besides watching your own account, from time to time take a look at what other online brokers have to offer. It is a fast-changing field, so staying up-to-date is essential for finding the best online broker and deal available.
How to Avoid Online Broker Fees: Download Full Infographic
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