Transaction fees, the good, the bad, and the ugly

I’ve seen several sites mention that the transaction costs for purchasing a stock make the purchase not worth it. However, from personal experience I’ve seen that the transactions costs associated with purchasing a certain stock make the stock a worthwhile investment, particularly when just starting out your investments. You simply need to save enough up in your account so that you can purchase enough shares of that stock.

Most of the brokerage firms allow you to put ANY amount into an investment account. Keep in mind that doesn’t mean that you can purchase certain mutual funds in the account since they often have a minimum amount that you need invested into that specific fund, in order to purchase more shares. Don’t forget that the account is like an armored car that carries your cash around for you so that you can invest it, while the stocks/bonds/funds are more like the people who take your cash and drop it off at it’s destination for purchasing those stocks/bonds/funds as you choose.
I’ve seen fees ranging from as low as $5.95 up to $12.95 per transaction. Which means that if you bought 1 share, the transaction fee would be the same as if you bought 1,000 shares.
That’s what this article is referencing and trying to help you understand that it will often be better if you wait to purchase a stock until you can pick up more shares.
For simpilicity, I’ll just use the term “investment” to refer to either stocks, bonds, or funds that are purchased within the account.

The table below is used to show in a brief way, how the costs can be advantageous or not.

Analysis of $7.95 transaction fee costs on a per-share basis
# shares Cost per share
1 $7.95
5 $1.59
10 80¢
20 40¢
30 27¢
40 20¢
50 16¢

Okay, so how does this help me? … one would reasonably ask.
Let’s say that an investment goes up/down 10¢ or more during a certain time of the year. This may be just after a dividend is paid, or a company that makes Christmas products is expected to achieve extra sales because of some new product it has developed.
If you only have enough in your account to purchase a small amount of shares of that investment, and on average it only goes up or down a small amount per day, then you should wait until you can purchase more of them. Likewise if you have enough to buy a larger number of shares of an investment, this will lower the transaction fees per share cost which also makes it faster for when it can be making money for you!

For instance, it is simple to see that if you only bought 5 shares of a company that averages 10¢/day going up or down, the investment could take 16 days or more just to recoup the transaction fee!! :-(
If you wanted to buy an investment where the average amount that it changed was 10¢/day, you wouldn’t want to buy anything less than 40-50 shares of that investment. The reason for this, is because if the investment goes down shortly after you purchase it, the transaction fees will exagerate the amount it went down. It also slows down how quickly it will go up!

It would be best to simply keep putting money into your account until you can purchase that many shares of the investment, which is why it is best to fund your accounts with as much money as you can. After all, if you simply kept putting money into your account until you saved up enough to purchase say 200 shares of the same investment, the costs of the transaction fees would soon be covered if the stock went up only 4¢!

As another quick example, let’s say you could purchase 1 share of Google at $728/share. Since they can and often do either go up or down $7/day, then buying only 1 share can be beneficial as far as transaction costs are concerned, so every day you may be either up or down.
By the same token, if you bought a stock such as ADP (currently $64.57/share), you would be able to get 11 shares of that particular stock. If ADP on average went up/down 72¢/day, the stock purchase could make sense from a transaction cost perspective.
The other benefit for ADP is that it also pays out a dividend of 44¢/share, which may be a better choice to cover the downside since the stock may go up or down or stay flat, but after 2 years the transaction fees are paid and any increase/decrease adds more/less to you increasing the size of your account. This last thought of figuring out which investment is better from an overall perspective, is outside the scope of this post, but there you have it anyway.

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2 Responses to Transaction fees, the good, the bad, and the ugly

  1. I’m considering opening up an account with Fidelity again (a Roth this time around), because I saw that the CEO was offering the first 200 trades being free. That would be almost $1,600 left in an account once hitting that many trades. Not to mention even though I’m a fairly active trader since I trade about 8-10 times each year, it would take me almost 20 years to hit that many trades. :-)
    Thanks for stopping by Ben, and have a great day or night!

  2. Ben says:

    Good point. The economies of scale do help you as your balances grow. This is an advantage we have as individual investors. Most institutional investors actually pay commissions on a per share basis. Plus Vanguard and Charles Schwab offer no commission ETF trades and some brokers give you a number of free trades if you maintain a minimum balance.

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