Thursday, April 9, 2009

Fees and commissions and how they affect your portfolio.

One of the things that you do not hear often is the impact of fees and commissions on your portfolio. Their is a good reason for this. The financial system has no advantage in whether your portfolio grow and shrink. That is because they derive their incomes from fees and commissions.

When you start investing you need to know that whenever you do a transaction you will need to pay a commission. When you buy or sell a share or any investment instrument you pay a commission. You might not realize it but if you start with a small sum you will soon find that you will have paid a large part of it to the brokerage firm as commissions.

To understand what it meant to your portfolio. Lets assume that you invest 1000 dollars with a fee of 10 dollars per transactions. You buy five types of shares. The fees is now 50 dollars. This is 5% of the investment. So if your portfolio has a rate of return of 5% per year then it meant that you will have to wait more that one year just to break even. So imagine that you start to buy and sell shares very soon your portfolio will start to shrink at a rate of 5 dollars per transaction. As you can see it is not a viable option for the new investment to trade often. That is the reason that I favour the buy and hold strategy, at least in the first few years.

So what to do?

When it come to fees the different instruments are not equal to each other. So here is an analysis of different instruments and how they differ when it come to fees.

1. Bonds, gilts and treasury bills.

These can be available at any central bank or their regional offices. They come with little fees.
However their return is not that mush.

2. Exchange traded funds, mutual funds and index funds.

These are my favorite when it come to reduce fees and commissions. It is ideal for the beginner investor. In fact it reduces the impact of diversification which is a great fee and commission eater. I think that a beginner should stick with these funds until they can understand the market and trade on their own in stocks.

3. Stocks

Stocks is the investment instruments that has the highest fees and commissions. In order to have a good portfolio an investor will have buy into many stocks and that will make the initial commision payable high. So i would advise any new investor to stick to bonds, cds, and funds.

4. CD, Certificate of Deposits

These come with small fees and some banks do not charge any. But Beware most banks do have a penalty when to come to taking your moner before the maturity date.

As you can see the fees and commisssions should be kept in mind if you a new investor. If you are not careful the only person that will benefit is the broker.

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