By Dr. Steve Sjuggerud
Warren Buffett and Bill Gross, two of the most influential investors in the world, both think that stocks will return 6% to 7% a year over the next decade. At that rate, you’ll double your money in 10 years. However, if you’re giving away 2% or more in fees and expenses, it will actually take you twice as long to double your money!
Looked at another way, the bank is paying you less than 2% a year. Stock dividends are less than 2% a year. Heck, if you’re paying 2% or more in fees, you’re losing money. The point is, 2% matters. Here, then, are eight ways to cut costs and keep that 2% in your own pocket.
1. Reduce costs by paying no more in commissions than you have to.
Ameritrade.com charges eight bucks per stock trade. If you’re trading your own ideas, but you’re calling in your orders to a company like Schwab, you’re probably paying around 50 bucks a trade. If you place 10 orders a month, that’s 120 orders a year — or $6,000 a year in commissions at Schwab vs. less than $1,000 at Ameritrade. Nothing against Schwab (I’ve got money with them myself), but why should you give away $5,000? For frequent traders, Ameritrade offers a good mix of budget and quality. For a good all-around discount service, Schwab has been good to me. And for full service, Merrill and Morgan Stanley do a nice job. For more specific ratings of brokerage firms, both discount and full-service, check out http://www.gomez.com
2. Reduce costs by paying attention to the spread when appropriate.
Let’s say you’ve got a 5-year-old car worth $12,500. You take it to a dealer to see if he’ll take it off your hands. He says he’ll give you $10,000 for it. But you say, "Hey, that’s not fair. You’ve got the exact same car on your lot for $15,000!" My friend, that’s the spread. If you’re selling your car, you’d like to get $12,500 — not just $10,000. And if you’re looking to buy, you’d much prefer to pay closer to $12,500 than the $15,000 the dealer is asking. What you want to do is eliminate the spread.
With big stocks, like Microsoft, Intel, and basically any other company you’ve already heard of, the spread is not a concern. There are so many buyers and sellers that you’re best off just putting in a market order and owning the shares immediately at the market price. (In fact, the spread on Microsoft, a $50 stock, is only 3 pennies as I write this.)
But with small stocks and options, which can have a significant spread, you’re better off wheeling and dealing. With these, it’s more risky to put in market orders. I personally learned this lesson the hard way when I was starting out. I paid $7 at the open for a $4 option. The option went up 50% to $6, and I still lost money. Lesson learned: Never use market orders on thinly traded positions — especially at the open!
3. Reduce costs by knowing how to identify "hidden costs" of mutual funds.
Bill Gross is the biggest bond-fund manager in the world, and for good reason: He’s earned double-digit returns for investors for 30 years. His flagship Pimco Total Return Fund now has over $50 billion in assets. Wow! It’s amazing that so many people have bought this when you consider that bonds pay only about 4.5% in yield right now and this fund has a 4.5% up-front charge. So by paying this hefty fee, you may just break even your first year. Even worse, annual fees at this fund clock in at around 1% a year.
Meanwhile, Bill also manages a little-known fund, the Fremont Bond Fund, that does the same thing as the Pimco fund. Only it has no up-front charge and annual fees of only half a percent per year. Amazingly, this fund has less than a billion dollars in assets.
Why the big difference? My guess is, I’m sorry to say, investor ignorance. Brokers and financial planners sell the Pimco fund with the up-front fee because they pocket almost that entire 4.5%. If they sell you the Fremont fund, they don’t get paid. How can you find funds like this — and other ways to significantly reduce your costs? Use Morningstar.com’s Fund Quickrank. It’s free — and excellent. I’d even recommend springing for Morningstar’s $99 annual fee, because they have reports on thousands of funds. I think you can get a 30-day free trial. Check it out.
4. Reduce costs by making fewer transactions.
Look, 90% of fund managers can’t beat the market — and they’re professionals. If the market averages 12%, you’ll get, on the average, a return of 10% from a fund manager. Why is this? Because you get the return of the market minus the fund manager’s fees and cost of doing business (commissions, spreads, office space, etc.). When you understand what I’m trying to say here, you can see that the cost of doing business is a big hole in your wealth bucket. The more transactions you make, the bigger the hole. So trade as little as possible, and you’ll probably end up better off in the long run.
5. Reduce costs by paying attention to capital-gains taxes.
As you’re likely well aware, if you hold a stock for over a year and then sell it, your tax rate is substantially lower than if you hold it less than a year. So if you need to raise cash but there’s no absolute reason to sell the stock right now and you’re close to the one-year mark, wait. You could save yourself thousands of dollars.
6. Reduce costs by taking maximum advantage of tax-deferred retirement programs. (This one is important!)
What’s the best way to save money these days? Stuff your 401(k) (or similar retirement program) to the max. If, for example, you make $100,000 this year and put the maximum of $11,000 into your 401(k), the government will tax you on only $89,000. So, in effect, you’ll be saving yourself a huge amount in taxes.
7. Reduce costs by using margin sparingly — or not at all.
This probably isn’t a problem for you, because you’re probably not using margin. Still, you should understand the concept. Margin is money you borrow to buy stocks. So, if Warren Buffett is right and we can expect only 6% to 7% a year in stock returns — yet it costs you 6% or more to borrow money — borrowing money to throw at stocks is just plain not a smart idea. Simple as that.
8. Reduce costs by eliminating "hidden" margin costs of your debt.
Why anyone has money in the stock market AND tens of thousands of dollars in credit-card debt, used-car loans, etc. is beyond me. The math is simple: The cost of the money you are borrowing is much higher than the potential return on your money in the stock market. The solution? Sell stocks (which may return only 6% to 7%) and use the proceeds to pay off your credit cards and used-car loans.