Friction is the force that makes moving something more difficult. For example, friction may make sliding a sofa across a carpet difficult.
Friction makes it more difficult to accomplish your task (although lack of friction, as in spinning your tires in snow, can also be a problem). In this case, I am talking about the kind of friction that makes it harder to achieve your investing goal.
Investing in stocks creates friction, such as brokerage fees, transaction costs, taxes, research expenses and so on.
Obviously, you want to keep expenses as low as possible because the more dollars that friction scrapes away, the fewer dollars left for you. Here's how you can reduce frictional expenses:
Brokerage fees
Brokerage fees are what you pay to an investment firm (stock broker) when you buy or sell a stock. Although the advent of discount brokerage has reduced the cost of buying and selling stock, there are still dollar differences between firms.
Realistically, if you trade infrequently, the differences will be insignificant for most stock investors. However, if you trade stocks frequently, your choice in brokerages can make a big difference over time.
You should not choose a broker just on fees alone. The cheapest solution may not be the best one. If a broker regularly screws up your trades or makes mistakes on your account, it might be worth paying a little more and avoiding the hassles.
If you have a significant amount to invest (different brokerages have different requirements) and trade frequently, some stock brokers offer a fixed fee approach, which is usually a percentage of assets on an annual basis.
For example, if you have $200,000 invested, the firm may charge you 1.5% ($3,000) as an annual fee. You pay this fee whether you make money or not. These accounts often include advice and research.
Transaction costs
Transaction costs can include fees such as those charged by mutual funds or, in some cases, bond trades. While technically not brokerage fees, these expenses have the same dragging effect on your investment earnings.
You can minimize these fees by making sure you understand the costs associated with each type of investment. For example, mutual funds charge annual fees to manage the fund. There is no evidence that paying higher fees to fund managers results in a better return for you.
In fact, the result is often just the opposite. Look for low fees and don't fall for the "high fees, high return" scams.
Taxes
There is a simple rule that will help you minimize your stock investing taxes: Always hold a stock for a full calendar year before selling for a profit. If you do so, you will pay the capital gains tax rate, which is almost always less than your personal income tax rate.
If you sell a stock for a profit that you have held less than a calendar year, you pay ordinary income taxes on the gains in most cases.
Research
Many stock investors do their own research and there are plenty of resources out there for free. However, there are also some excellent resources that cost money and may be worth the expense.
The issue is not should you pay for research (or recommendations), but whether it helps you make more money. See the section on annual fees in the brokerage section above.
Most stock investors would be willing to pay for services that consistently helped them make money. Just make sure any research or recommendations you buy helps you.
Conclusion
You can't avoid all the fees and expenses of investing in stocks, but you can be smart about reducing the fees that add nothing to your investing success.
