What is the COST of INVESTING in The Stock Market?
"What will it cost?" is a sentence I often use... with my lovely wife. This video won't help spouses peacefully balance the monthly budget, but it will help you better understand the general costs you need to be aware of when investing in the stock market.
what will it cost?
INDIVIDUAL STOCKS
You want to buy some ownership in the Small Cap Stock, Titan Machinery (TITN), a company that sells new and used construction and farming equipment. Guess what, on most platforms (Robinhood, Schwab, Fidelity, etc...) you can hop on and buy it without any trading costs, very neat.
Robinhood Pricing: https://robinhood.com/us/en/support/articles/trading-fees-on-robinhood/
Schwab Pricing: https://www.schwab.com/pricing
Fidelity Pricing: https://www.fidelity.com/why-fidelity/pricing-fees
STOCK FUNDS
If you are a bit nervous choosing which small cap stocks to purchase (their are in fact well over 1,000 to choose from - https://stockanalysis.com/list/small-cap-stocks/), you might explore purchasing a small cap fund instead. This way, you are "hiring" a professional to choose which small cap stocks to buy for you.
EXPENSE RATIO
A stock fund is going to charge what is called an "expense ratio". This is the cost of the fund. This expense is charged on an annual basis. If it is 1% and you put $100,000 into the fund, the fund will deduct $1,000 dollars each year. Their are a variety of different types of funds. Mutual Funds. Exchange Traded Funds. Active Funds. Passive Funds. To name a few.
ACTIVE FUNDS VS PASSIVE FUNDS
Let's assume you want to "hire" someone and buy a small cap fund, instead of trying to buy the best small cap stocks on your own. Your next decision will be whether to choose an active small cap fund or a passive small cap fund.
An active fund simply means that the manager of that fund is going to actively buy and sell a certain number of small cap stocks. Their goal is to buy the best small cap stocks and outperform the Index (which reflects how all small cap stocks perform in aggregate). Because this takes time, energy, research and resources, they typically charge a higher expense ratio.
A passive fund (or index fund) means the manager of that fund is going to buy a majority of the small cap stocks. Their goal is to track the index, giving you diversified exposure to the small cap space. Because this takes less time, energy, research and resources, they typically charge a lower expense ratio.
EXPENSE RATIO COMPARISON
Here is an expense ratio comparison of some of the most popular Small Cap Funds in order from least expensive to most expensive (Morningstar 18 best small cap stocks for 2024: https://www.morningstar.com/funds/best-small-cap-funds-2):
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VSCIX - Vanguard Small Cap Index 0.04% (index fund)
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VB - Vanguard Small-Cap ETF 0.05% (index fund)
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DFAS - Dimensional US Small Cap ETF 0.26% (semi passive, not index fund)
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DFSTX - DFA US Small Cap 0.27% (semi passive, not index fund)
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PRDSX - T. Rowe Price Integrated US Sm Growth 0.80% (active fund)
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BOSOX - Boston Trust Walden Small Cap 1.00% (active fund)
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WAAEX - Wasatch Small Cap Growth Investor 1.15% (active fund)
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CIPSX - Champlain Small Company 1.27% (active fund)
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BCSIX - Brown Capital Mgmt Small Company 1.28% (active fund)
RETURN PERFORMANCE COMPARISON
Here is a comparison of return performance on 5 of those funds and the small cap Index (Russell 2000). Three active funds and two passive funds.
2023
WAAEX (active) 21.24%
PRDSX (active) 21.16%
BCSIX (active) 19.12%
VB (passive) 18.23%
DFAS (semi passive) 17.83%
Russell 2000 Index 16.93%
2020 -2023
DFAS (semi passive) 9.76%
VB (passive) 8.1%
PRDSX (active) 6.68%
Russell 2000 Index 6.39%
WAAEX (active) 4.92%
BCSIX (active) 0.70%
2010 - 2023
PRDSX (active) 12.73%
VB (passive) 11.44%
DFAS (semi passive) 11.39%
WAAEX (active) 11.38%
BCSIX (active) 11.15%
Russell 2000 Index 10.24%
WHICH FUND SHOULD YOU CHOOSE?
So.... um.... which small cap fund should you choose? The least expensive? A more expensive active fund? A fund with momentum, performing the best recently? A fund with staying power, performing the best over an extended period of time? What about all the other small cap funds out there? What about all the other stocks funds out there in other segments of the market? Decisions, decisions.... is their anyone out there that can help!?
FINANCIAL ADVISORS AND SUPERHEROES
Only one group of brave souls... they are special, powerful, intelligent... The Avengers.
Just kidding, not even the Avengers can help you here, only The Financial Advisors.
Yes, I just compared my industry to a powerful superhero team.... I know being a financial advisor doesn't make me "cool"... it probably does the opposite... But someone must be overseeing Captain America's investment portfolio, keeping the Hulk calm during a market downturn. No one ever thinks about the little guys behind the scenes making sure everything is running smoothly... let's get back on track.
COST OF A FINANCIAL ADVISOR
What is the cost of using a financial advisor to help with the fund and stock choosing? Advisor fees can vary widely depending on the level of service provided, geographic location and other factors. With that "disclosure" put forth, here is some information you might find helpful:
How they might charge you
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Assets under management (AUM): They charge an annual fee, based on a percentage of the assets they manage for you, similar to the expense ratio already explained. This fee tends to scale down the more they manage for you. This is the most common way a financial advisor will charge you.
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Commissions: The advisor is paid from the investment products recommended (that inevitably come out of your pocket). Typically, these commission paying investment products are more expensive to recoup the commissions paid out to the advisors.
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An Hourly Fee: Similar to an attorney, they will charge you for the hours they spend advising you on all things financial.
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A Financial Plan Fee: They might charge a one-time fee for putting together a financial plan for you.
What it might cost
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AUM: Between 0.25% and 1% depending on the type of advisor, among other factors. Robo advisors will be less, in person advisors you develop personal relationships with will be on the upper end. In person advisors will often have account minimums.
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Commissions: These can vary, 3% to 6% is a good general range to expect.
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Hourly Fee: $150 to $400 an hour
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Financial Plan Fee: $1,500 to $3,500 for a one-time financial plan
Sources:
Nerdwallet - https://www.nerdwallet.com/article/investing/how-much-does-a-financial-advisor-cost
SmartAsset - https://smartasset.com/financial-advisor/financial-advisor-cost
USA Today - https://www.usatoday.com/money/blueprint/investing/financial-advisor-costs-and-fees/
DO YOU NEED A FINANCIAL ADVISOR?
Maybe. This is a delicate topic being that I am one. I think I could probably convince you of my worth and value, even demonstrating how a financial advisor can make up for their fee, and then some. BUT, I also understand their are many that like to save a few bucks and do things themselves. If you prefer giving your own car an oil change or finishing your own basement, you might be the type of person that will never see any value in someone like me... because you can just do it yourself... and that's okay. I also recognize some people do those things themselves because they know how and enjoy it... I am not one of those people.
For those with a proclivity to delegate, who are working with a financial advisor currently or for those potentially interested in working with a financial advisor, I conclude with this:
If financial planning is not robustly offered and included in the financial advisor fee you pay for investment management and oversight, I would reassess things. Financial planning being any decision that deals with dollar signs. Here are some examples to give you an idea:
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Tax planning
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Business planning
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Estate planning
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Retirement Planning
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Executive Compensation Planning
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College Education Planning
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Charitable Planning
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Medicare Planning
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Social Security Analysis
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Pension Analysis
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Debt Analysis
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Insurance Review
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Next Generation Planning
Using a financial advisor can add value managing your investments alone. Using a financial advisor can become an easy decision if they manage your investments AND provide personal planning and analysis.
IN CONCLUSION
Buying individual stocks yourself = Likely no cost
Buying stock funds yourself = Expense ratio
Using a financial advisor = Expense ratio and Advisor Fee
Sources & Disclosures found in the video link on Youtube