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The Importance Of Keeping Your Dealing Costs Low

What’s the biggest mistake a newcomer to investing in shares makes? Well, possibly the biggest is seeing it all as a get-rich-quick scheme rather than taking the slow-and-steady long-term approach that is an almost certain winner — and that problem is compounded by over-trading and ending up paying far too much in charges.

Suppose you’re buying and selling in £1,000 lots, and you’re using a stockbroker who charges a flat £10 per deal. Whenever you buy and subsequently sell a shareholding, you’ll be paying £10 per trade plus 5% stamp duty on the purchase. And on top of that, you also have to beat the difference in the buy and sell price for the stock (known as the spread). With a heavily-traded FTSE 100 company the spread is often negligibly low, but for the kind of smaller companies usually favoured by frequent traders it’s often a couple of percent — and with some very small and thinly-traded companies it can even be in the tens of percent.

Anyway, with a 2% spread so you’d be £45 down on a buy-then-sell deal before you can make any profits (two trades at £10 each, plus £5 stamp duty, plus £20 in the spread). So you’d need a 4.5% gain in the share price just to break even on your £1,000 investment.

Let’s see a couple of examples…

Suppose you start off with a modest lump sum of £1,000, and then you can afford to add an extra £100 a month. I reckon you stand a realistic chance of getting annual returns averaging around 6% (with so many dividends alone yielding 5% and better out there). Now, even if you end up paying 1% in costs per year (and that’s pessimistic — if you look for companies you want to hold for many years, you’ll incur just one charge per investment).

After 20 years, you’d have invested a total of £25,000 and would be sitting on a pot worth more than £43,000 after charges — a profit of £18,000!

But how about our frequent trader, who invests in smaller companies, and buys and sells once per year per holding, incurring 4.5% in costs per year? Well, they’ll only be netting the equivalent of 1.5% per year, and they’ll end up with just £29,000 after 20 years — a profit of only £4,000. To equal our long-term buy and hold (LTBH) approach, they’d need annual returns of 9.5%.

And if they trade each position twice per year? They’ll be paying 9% in costs and would have to achieve an annual return of 16% to equal the LTBH investor. What was it Woody Allen said, a stockbroker is someone who invests your money until it’s all gone? If you trade this way you’ll easily be able to do that all by yourself.

The lesson seems clear — use a stockbroker who offers low charges, and avoid over-trading by buying shares that you want to keep for decades.

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