How To Lower Investing Costs
The Need to Lower Investing Costs
Many people who follow financial news have heard about how the graffiti artist who created murals for Facebook became a millionaires being at the right place at the right time. He may have worked hard for a period of time but it’s not as if he toiled for a long 30-40 years to etch out a decent living. So when we hear such stories, it’s easy to think that getting rich is miraculous or “just happens.” Well, for the majority of people, wealth doesn’t “just happens.” We need to be methodical and savvy. We need to be very cost conscious. We need to lower investing costs.
While we cannot control things like interest rates, foreign currency directions, and federal deficits, we can and should control our investment costs. We might think that a few dollars or basis points (another way to say percentage) doesn’t matter, but the reality is that small cents and figures do matter a lot over long periods of time. Take the example of two investors putting $1,000 to work, one investing in a fund costing 1.25% vs another costing only 0.5%. We compare both funds over 10, 20, 30, and 40 years. The less expensive fund trumps the more expensive one by $1,394, $5,550, $16,586, and $44,073 at the 10, 20, 30, and 40 year marks, respectively.
In the second example, you start off with $10,000 and an additional $5,000 per year. In this example, the impact is even more dramatic. At the end of 20 years, the smart, cost-conscious investor will have an extra $22,606; and at the end of 40 years an extra $244,290. Even in 40 years, an extra quarter-million dollars will be a big sum. That could easily pay for the remaining mortgage balance, a big part of health care expenses during retirement, annual vacations for a decade, and maybe more.
So just by selecting the fund with lower fees, you’ve won a huge battle in the investing game – costly fees!
Tony Robbins talks about the importance of paying attention to fees in this short video.
How to Invest for Less
Now that you know the importance of investing for less, the next step is to take your first step in that direction. With tens of thousands of mutual funds and ETFs, the choices are limitless. As a foundation, I’d suggest that you start with several index funds to minimize costs. Index funds track broad market indices and are not actively managed, translating to better cost efficiencies. Even with index funds, I’d recommend that you visit their websites and read some of the articles I’ve found for you to educate yourself and save some time. Depending on your age range and goals, you will want an assortment of index funds. In the future, I’ll write more about selecting specific funds, but for now, I just want to introduce you to index funds.
At the end of the article, there will be several links to low cost index funds.
401k Funds Often Have Lower Fees Than Similar Funds in IRAs
Since most large employers offer 401K plans, there’s a good chance that you have access to one. Because the funds offered in a 401K plan often become the de facto selection of participants, employers have often negotiated favorable fees on behalf of their employees. Clearly, setting aside money can earn matching amounts from the employer. Another advantage is that similar or identical funds offered in a 401K can have lower fees than one offered in an IRA. There are several implications for this – (1) If you’re debating whether to invest in a 401K vs an IRA, the lower fees of funds available in a 401K can make investing in a 401K first the smart decision; (2) If you leave a job, instead of automatically cashing out or rolling over the 401K money into an IRA, wait until you’ve settled into your new job and see what the new employer 401K investment options are. If there are similar low fee funds, then it’d make sense to transfer the existing 401K to your new employer’s 401K plan.
Trade Stocks for As Little As $1
Bill Gross, the famous bond manager, once advised investors with less than $50,000 to invest to focus on mutual funds. There’s truth and wisdom to that because below a certain amount, whether it is $50,000 or $30,000, it’s harder to be cost effective and achieve diversification. If you have already accomplished diversification with mutual funds with the first $30-50k and feel ready to invest in stocks, it’d make sense to open an account with a discount brokerage. Unless you have $250,000 or more to invest, most advisors will direct you to direct online brokerages anyway.
It’s hard to imagine that as recently as 1980s, the average commission was $45 but that it could climb much into the hundreds or thousands depending on the size of the order. With the advent of discount and online trading pioneered by Schwab and similar discount brokerages, commissions have plummeted. Most discount brokerages charge less than $10 to trade 500-1000+ shares. So for less than $10 in many cases, you can trade $10,000+ of stock, which comes out to 0.1% or 10 basis points. Most active managers charge 50 basis points or higher for retail investors. Some “extreme discount” brokerages like Interactive Brokerages charge as little as $1 to trade that many shares. Some brokerages to start looking at include Suretrade, TDAmeritrade, and Charles Schwab.
Click here to read a good article that compares online brokerages.
Find a Fee Only Advisor
Most wealth management firms require at least several hundred thousands in investable assets for an advisor to work with you. However, if you really need unbiased advice, go with a fee only planner. So instead of paying the advisor a commission each time an investment is purchased or sold, you’d pay a fee only when you sit down for advice (usually 1-2x/yr). As much as possible, you want to avoid paying commissions on transactions because it encourages churning, the act of generating activity solely for the purpose of generating a fee.
Click here to find a fee only advisor in your area.
Dividend Reinvestment Investment Plans (DRIPs)
Prior to the advent of discount brokerages, DRIPs were one of the few ways for the Average Joe to trade stocks commission-free. By committing a small amount to the initial shares, investors can buy additional shares of the same stock with the dividends.
As an illustration, famous Wharton School of Business professor and famous writer Jeremy Siegel analyzed the performance of Phillip Morris (PM) between 1925 and 2003 and found that the tobacco company produced a 17% average annual return if dividends were reinvested, beating the S&P by 7.3% a year. If you had invested just $100 in 1925, your investment would be worth nearly $21 million at the end of 2003!!
Now that’s the power of compound interest at work!
DRIPs Especially Good for Retirement Plans
One situation especially ideal for DRIPs is to buy stocks via DRIPs in a retirement plan. The logic is that in a retirement plan like an IRA, dividends and capital gains are tax-deferred, which allows your investment to compound tax-free for longer periods. One caveat that should be noted is the dividends used to buy additional shares are taxable if invested in a non-retirement account. In other words, if you invest in a DRIP in a non-retirement account, you have to pay taxes on the dividend (used to buy more shares) even though you did not receive the dividend as a cash payment. That’s why I think that DRIPs are especially good for retirement accounts because of the tax advantages.
One expert especially known for DRIPs is Charles Carlson, who’s a well-known author and editor of the DRIP Investor. If you’re really interested in learning more about DRIPs, I highly recommend reading some of his books, many of which should be available at your local library.
Educate Yourself in Low Cost Investing
There is no better way to become a better investor, and a smart and cost-conscious one at that, than to educate yourself. In the olden days, you’d have to go down to the local library to read stock reports from ValueLine and mutual fund reports from Morningstar. Now with everything online, you don’t even need to leave the comforts of your home to get smart on investments. There are so many good blogs (like this one; yes, a shameless plug) that offer really great advice on investing and cost-effective ways to do it. Remember, when it comes to free information online, Google is your best friend.
Personal Finance and Investing Periodicals Worth Reading
If you’re just starting out, I’d gravitate towards more foundational magazines like Kiplinger Personal Finance and Money (what I liken to a “high school personal finance curriculum”). As you become more informed and comfortable, graduate to Fortune, Forbes, and The Wall Street Journal (“lower division college curriculum”). When you’re ready to move on, try Barron’s and Investor Business Daily (“upper division college curriculum”). I read all of these regular mainly to keep track of what the most popular finance writer like and to generate ideas for myself. With the exception of Barron’s most of these periodicals are either monthly or bi-weekly. Typically, what I do is go to a large bookstore 2-3x a month and must browse these magazines (for free) and either write down the best ideas for further research.
Advisors Worth Following
I’ve found that these advisors and websites have access to great ideas and following them can be helpful – Suzy Ormon, LearnVest, and Dave Ramsey. Suzy Ormon is a former stockbroker turned popular personal finance author / show host extraordinaire. LearnVest was founded by former Morgan Stanley analyst turned entrepreneur Alexa Von Tobel who came up with a sensible, easy to follow 50/30/20 guideline for budgeting and saving. Dave Ramsey is a well-regarded financial writer and motivational speaker who hosts his own talk show. Of course, there are many more “gurus” out there, but here are a few that could be a good start. You don’t need to follow all three. Learn about them and pick one to start with.
Websites Worth Tracking
I use tools and information from Yahoo Finance, Google Finance, Fidelity, Etrade, MagicFormulaInvesting, gurufocus, Seeking Alpha, insider trading, etc. I use Yahoo and Google for basic summaries and charts on stocks. For specific high quality stocks trading at favorable valuation, I use MagicFormulaInvesting, a website started by Joel Greenblatt of Gotham Capital, a well-known hedge fund manager. I use the other websites for various articles to generate trading ideas.
In terms of actual investors and money managers, some of the better known bond managers include Bill Gross and Jeffrey Gundlach. Equity investors include Warren Buffett and Jim Cramer. Savvy hedge fund managers accessible to the media include Bill Ackman, Carl Icahn, David Einhorn, and David Tepper, just to name a few.
Bill Gross and Jeffrey Gundlach are famous bond managers and have held the title of “Bond King” at various stages in their distinguished careers. Warren Buffett of course is the octogenarian manager who’s arguably the best investor of our generation. In 1965, one could have purchased 1 share of Berkshire Hathaway for $14.86. Today, that share is worth $221,000, increasing by 14,872x. Jim Cramer of course is the ubiquitous CNBC talk show host with an encyclopedic knowledge of the markets. Though I find Jim Cramer to be more short-term focused his content is readily available and generate ideas for me. Of course, there are many that I’ve left out, for the general public, this is a good list to start with. Keep an eye out for their commentary. If you really want to track them closely, set up Google Alerts so you get emails when there’s news about them.
Summary on Lowering Investing Costs
Here’s a quick summary on how to keep your investment costs low
- Use low cost index funds
- Invest in low cost funds in 401K before you explore similar investments in IRAs and non-tax deferred accounts
- Take advantage of discount brokerages
- Research Dividend Reinvestment Programs to take advantage of commission-free stock investing plans directly with companies
- Use a fee only advisor if you need one
- Take advantage of free investment websites and information online and at your local library