Friday, November 20

Misers Avoid Transactional Costs... Part 1

When I was 18 I opened my first brokerage account with Charles Schwab. I had a lot of fun trading the stock market and I made some money doing it. After a year I decided to look at how much all this trading cost me. I found that my Schwab account, which had something less than $10,000 in it at the time, had racked up over $2,000 in transaction fees. I can't remember what I paid in taxes for all those short term trades.

Over the last year I've given a lot of thought to transactional, or frictional costs, and the long term damage they inflict on my net worth. As I attended the AAII conference last week I was surprised by the number of investment strategies offered by various professionals. Even more surprising were the number of attendees to their sessions. Here I am at a conference of supposedly intelligent investors and all around me are folks bragging about how successful the CAN-SLIM approach has been for them or how this new charting software they purchased "really works".

  • The right way to invest: Buy an investment and hold it.
  • The idiot's way to lose money: "Play the market", "trade stocks", etc.
It amazes me how someone can identify a "hot stock" by watching Mad Money or reading some investment newsletter. They buy shares without so much as reading a financial report from the company then sell just as quickly when their favorite guru tells them to or they find the next hot idea and need the money.

When you do this, you enrich the E*Trade's of the world, not to mention Uncle Sam. Brokerage fees and taxes eat up so much of your potential growth in net worth. What many will find is that you can earn even more money by doing your due diligence to find a solid company you'd like to invest in, buying a piece of that company and holding it. It's much more rewarding, in my opinion, to be able to follow that company over time and become somewhat of an expert in it. I get excited when I know a conference call has been scheduled or I hear about a new store under construction or some news story comes across my Google Alerts.

The penalty of frictional costs goes far beyond purchasing the stock of a publicly traded company. Tomorrow I will talk about how I avoid other transactional costs.

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