How Do I Keep Commissions and Fees From Eating Trading Profits?

Fact checked by Suzanne KvilhaugReviewed by Chip Stapleton

You work hard for your money. And you should be able to keep as much of it in your pocket as possible. But if you’re thinking of investing your hard-earned cash to increase your net worth, there are some things you should keep in mind. Investing comes at a cost.

There’s certainly risk involved which can eat away at your profits. But something else that can chip away at your bottom line is the cost—from fees to commissions. And it can all add up. So can you actually put your money away and keep your expenses low? The short answer is yes. Read on to find out more about how to keep these costs from depleting your profits.

Key Takeaways

• Investment expenses include brokerage fees, commissions, and management and advisory fees.
• Commissions and fees aren’t universal—they vary from firm to firm.
• Most brokerages no longer charge for trading stocks, ETFs, or mutual funds.
• Keep your expenses down by investing with a no-fee brokerage firm or trading house.
• Robo-advisors use algorithms to manage portfolios, so they may come with low or no fees.

Types of Investment Fees

Most investments come with some type of fee. It’s one of the only ways banks and other firms can make money. By charging you a fee, these institutions can keep running and offering you their services.

Even the simplest investment vehicle can come with some form of service charge. Some savings accounts, for instance, charge a fee if you don’t keep a minimum balance and you will incur a service charge if you make more than one withdrawal a month. It’s your money, so why do you get hit with a fee? The account is, after all, meant for you to save your money.

This principle—of charging a fee—is pretty consistent across the board. Businesses charge you money in order to keep and handle your accounts. But they also do the same when you want to move your money around.

At times, you may feel like you’re paying more than you’re investing. Surely, there must be a way to keep that to a minimum, right? Of course there is. But before we outline how you can keep your money in your account by not paying outrageous fees, here’s a quick look at some of the most common expenses that come with investing.

Brokerage Fees

A brokerage fee is charged by many different financial services companies including brokerage firms, real estate houses, and financial institutions. This fee is normally charged annually to maintain client accounts, pay for any research and/or subscriptions, or to access any investment platforms.

These fees may also cover instances if and when an account goes dormant. Brokerage fees may be a certain percentage of the balance held in a client’s account or a flat fee.

Commissions

Brokers and investment advisors often charge clients commissions for using their services. These are also called trading fees.

They basically pay for any investment advice or to execute orders on the sale or purchase of securities including commodities, options, and bonds. Commission charges vary from firm to firm, so it’s important to verify a brokerage’s fee schedule before you decide to use their services.

Management or Advisory Fees

Management or advisory fees are charged by companies that run investment funds. Fund managers are compensated with these fees for their expertise. Although they can vary between funds, most of these fees are based on a percentage of the assets under management (AUM) in each fund.

The Basics of Trading Expenses

There is no universal system regarding trading commissions or other fees charged by brokerage firms and other investment houses. Some charge rather steep fees for each trade, while others charge very little, depending on the level of service they provide.

Discount brokerages no longer charge for trading stocks, ETFs, and mutual funds. This change has become a huge saver for investors. If you plan on trading other securities, such as futures, options, and bonds, you will be charged and the amount varies by broker. The cost is usually per contract or per bond, for example.

Important

ETFs come with expense ratios; the fee that is charged for administering the fund. You’ll want to choose ETFs with low expense ratios if you want to keep costs down.

So, if your broker charges $1.50 per futures contract, the more futures contracts you trade, the more you’ll be charged. You’ll want to ensure that the returns you’re getting at least outweigh your costs.

For example, if you trade 10 futures contracts, you’ll be charged $15. If you earned $5 on your investment, you actually have a loss of $10 ($15-$5). You’ll need to earn at least $15 on your trade to break even.

Some brokerage firms may give commission discounts to investors who make many trades. For example, a brokerage firm may charge $10 per trade for its regular customers, but may only charge $5 per trade for customers who make 50 trades or more per month.

In other cases, investors and brokers may agree to a fixed annual percentage fee. Because you pay the same annual percentage fee, it doesn’t really matter how often you trade.

Keep Your Expenses Down

Even though fees are an integral part of the financial system, you don’t have to be beholden to them. There is a way that you can keep your expenses down and continue investing.

Consider investing your money with a firm that charges no commissions or fees for stock and ETF trades. Some of these firms also waive the minimum deposit requirement, so you can start with a low balance at no additional cost.

You will, however, want to check on their fee structure for other investment vehicles along with any other fees they may charge to see if it balances out.

Automated investment platforms may also help cut down on your expenses. Robo-advisors are a relatively new trend in the financial industry and can be great for small investors because they have low fees.

This means more money in your pocket. They can afford to do this because they’re automated, so they don’t have anyone physically managing client accounts. Instead, robo-advisors use algorithms to maintain and reallocate your holdings according to your risk tolerance and investment goals.

Advisor Insight

Dave Rowan, CFP®
Rowan Financial LLC, Bethlehem, PA

Minimizing commissions and fees can have a huge impact on your investing career. Here are three ways to do so:

1. Invest in exchange-traded funds (ETFs) rather than mutual funds. The expense ratios are almost always lower for an ETF versus a comparable mutual fund. It is now very easy to build a low-cost, well-diversified portfolio using ETFs with an expense ratio of 0.25% or less per year.
2. Avoid products with front-end loads, back-end loads, or 12b-1 fees. These are typically found within mutual funds, but not ETFs.
3. Seek out ETFs with no trading fees. A growing number of fund families are waiving trading fees on their ETFs.

If you do decide to invest in a fund with a trading fee, try to invest more than $1,000 per fund.

How Can I Invest Without Paying Fees?

Today, there are many options to invest without paying fees. Many brokerage firms, such as E*Trade and Charles Schwab, don’t charge investors for trading stocks, ETFs, and mutual funds. You can simply create an account with these brokerages, deposit money, and start trading these securities without incurring fees. Note that they do charge fees for other securities, such as futures, options, and bonds.

How Do Investors Pay No Taxes?

There are some legal methods to avoid having to pay taxes on investments. For example, Roth IRAs are funded with after-tax money and when you are legally allowed to withdraw, you will not pay taxes on the contributions or the earnings. You can also use capital losses to offset ordinary income to reduce your taxes.

What Are Commissions in Investing?

Commissions are charges made by an investment professional for buying or selling securities for you. They are to compensate the professional for their work. Commissions are usually a set percentage of the value of the investments traded.

The Bottom Line

Trading commissions and fees eat into your investment returns; as such, you want to keep them as low as possible. If you’ll primarily be buying and selling stocks, ETFs, and mutual funds, you’re in the clear, as most brokerages now don’t charge for this type of trading activity.

If you plan on trading securities that have fees, such as futures and bonds, then you’ll want to strategize on how best to keep these costs as low as possible.

Read the original article on Investopedia.