Reducing Investment Expenses
Dear Dollar Stretcher
I'm interested in cheap ways to invest. If I want to begin investing extra money, what are some inexpensive ways to do it? Going through a discount broker can really cost money. Of course, with mutual funds, you can invest directly with the company, but are there other ways to cheaply invest other kinds of investments (e.g., stocks, Treasury bills)?
Congratulations to Allison for beginning an investment program. And, she's right to be concerned with the costs of investing. Commissions, fees and transaction costs can significantly reduce the growth of your money.
Generally you'll find cost in three areas. A fee or commission when you buy. Management fees during the time that your money is invested. And, exit fees or commissions when you sell.
Usually the safest investments are also the ones with the lowest expenses. Savings accounts, CDs and savings bonds are all good examples. You won't pay to open, manage or close these accounts. Yes, the issuer will make a little money on you. But you'll have a pretty good idea of your rate of return before you open the account.
Allison should begin her savings program in a money market account. Technically there are two types. You really don't need to worry about the differences. The main thing is that you can be sure that $1 invested will be worth $1 plus interest when you choose to take it out. And, that you can take any or all of your money out whenever you want to.
Treasury securities (bills, notes and bonds) are usually for the person who can put away tens of thousands at a time. If you want the safety of U.S. Government backed debt but don't have that much money, take a look at U.S. Savings Bonds or some of the mutual funds that buy treasury securities. Most have very low expenses and will allow you to add smaller dollar amounts to your account.
The riskier and more complicated type of investments will have higher expenses. Even with all the technology available today buying a stock is still a complicated transaction. And that costs money. As a rule of thumb, unless Allison can afford to commit $2,500 or more to a specific stock, she shouldn't consider buying shares in individual companies. The transaction costs are too high. She'd be better off using mutual funds to own stocks.
Many mutual funds do not charge you to invest with them. They're called "no-load" funds. "Load" is a term that describes a sales charge that's "loaded" onto the fund. No-load funds are sold directly by the fund company to the investor.
Load funds are sold by brokers. Part of the load is paid to the broker as a commission.
Studies have shown that no-load funds perform as well as load funds. But that doesn't automatically mean that you should ignore load funds. Since a broker sells the load funds, they will do the necessary research to find a good fund that meets your objectives. The load is the price you pay for them to do that work.
You can find a good no-load fund for yourself. But you need to be willing and able to sort through the thousands of funds available to find the best ones for your situation. Don't kid yourself. Even with the help of magazines and websites that rate funds, you will spend some time and effort in finding the best one.
Remember that cost is not the only consideration. You would gladly pay a few dollars if it meant that you could earn many dollars. Mutual fund management fees should be clearly spelled out in the prospectus. For actively managed stock funds you can expect to pay up to 1.75% per year.
Sometimes you get what you pay for. Cheap management fees are no bargain if your investment doesn't grow. Conversely, higher fees are no guarantee of superior performance either. The bottom line is either you or a broker will need to compare records and study the investments.
Usually, beginning investors will do best with two types of investments. The very safe, like money funds and savings bonds. And mutual funds for long term growth.
One final thought. If Allison is carrying a balance on her credit cards, paying them off first could be her cheapest and best investment. Paying more than your minimum payment doesn't trigger any fees. She's guaranteed to earn whatever interest rate that the credit card company is charging her. That could be much better deal than she'd earn on any safe investment.