Protect Stock Profits - Watch those Expenses

One of the most important concepts in investing in stocks is to keep your expenses down.

The obvious reason is you can’t get ahead if you keep giving back profits through expenses. There are several areas where expenses and costs come into play:

• Broker fees
• Taxes
• Inflation

Inflation is a cost of doing business that’s just out there and it’s going to be high or not. You can adopt strategies to counteract it, but you can’t make it go away.

Broker fees and taxes you do have control over. Each of these comes into play when you trade (on the sell side for taxes). How you address them will make a difference in your long-term investing success.

Active Trading

These two factors make a strong case to avoid active trading. You are hit with broker fees and short-term capital gains (or losses) each time you flip a stock in under a year. There are other reasons that active trading is not a good strategy, but that’s a different article.

Let’s look at an example. You find a hot stock and in a short period, it moves from $25 per share to $30 per share – a 20% gain. Your $500 profit ($5 gain on 100 shares) looks good, but wait; it’s not really $500 is it?

First, we deduct the $30 roundtrip commission ($15 when you buy and $15 when you sell). Next, because this is a short-term gain you get soaked with a 28% tax bill (could be higher or lower), which comes off the $500 for $140. Your profit is now $330 – a 13% return.

Need Bigger Return

To really earn a $500 profit, your stock needs to move to about $32.36. Instead of a 20% gain, you need more than 29% to just to overcome the expenses and earn your $500.

How can you avoid or lessen these problems?

• Watch you commissions. If you do trade frequently, find a broker that offers discounts to volume traders.
• Watch your holding period. Holding a stock for one year qualifies it for long-term capital gains tax rate of 15% for most investors.
• You can offset gains with losses, but this is not an investing strategy. In other words, don’t take a loss just for tax purposes. Consult a tax adviser for the proper way to offset gains and losses.

Now the math in the example is rough and it doesn’t consider other investments or offsetting trades. However, the point is if you are going to trade frequently, you had better be very successful, because taxes and commissions are going to make it tough for just so-so trades to be successful.

Conclusion

Like the old saying, “it’s not what you make, but what you take home.” Watch your expenses and avoid killing your profits.