The stock market, or more broadly, the market for investments, is full of intermediaries. It is not a bad thing per se, as buying securities is a much more complex process than buying everyday products, like groceries. You cannot just go to the store, pick what you want, pay at the counter and be on your way. The value-added chain is longer, and hence you have to cover the costs of more elements than just the groceries costs, the cashier's salary, and the storeowner’s profit. Here’s broadly how this is organized.
In investing, even your wallet isn’t free
You will need an investment account which will hold your cash and securities. Running such an account requires payments processing and reporting, for which your broker or your bank sometimes demands a payment called the custody fee, which can be fixed or based on the amount of your money.
Storeowner’s profit, i.e. broker’s commission
Your broker is your window to the financial markets. Trade orders are normally placed with the broker, who then proceeds to fill them in the market. For this service, they demand a commission payment, usually structured as a percentage of the order value with some minimum absolute value.
You have to pay a little bit more to nudge somebody to sell
Unlike groceries, securities are bought for their profit potential rather than consumption. This is why there rarely is a particular party with a strong incentive to sell. All market participants are looking to profit from the sale of securities, one way or another. Here, another type of intermediary comes into play. Market makers provide liquidity to the market, that is – they sell when you want to buy, and they will buy when you want to sell. This comes at a price that you ultimately pay, as market makers buy at a lower price than they sell and make a profit this way.
Tax, tax never changes
You can think about it as VAT for investments: after closing a position, if you have made a profit, you have to pay a capital gains tax on it. However, if you closed with a loss, it will be netted against your profits. At the end of the year, all those profits and losses will be summarised by your broker, and you will pay the capital gains tax on the net result together with your personal income tax.
More people to pay for
So far, we assumed that you make your investment decisions yourself. If you want to use the services of an investment advisor, you would have to pay for him devising an investment portfolio tailored to your needs. This is usually costly, and you have to pay every time your circumstances change. Moreover, your portfolio is not managed, so the strategy can grow outdated. This is why you may decide to have your portfolio managed. This involves having an investment professional continuously looking at your account and managing it according to investment policy set beforehand. Such a service will cost you a flat management fee (1-2% of portfolio value annually) and a performance fee, a share of profits to incentivize the manager. If you don’t need so much personalization and are happy with some off the shelf solutions, you can look for model portfolios or mutual funds, which will usually have the same management & performance fee structure, but the fees should be lower.
Exchange Traded Funds
Exchange Traded Funds (ETFs) are usually algorithmically managed to follow the performance of an index - a portfolio of stocks. They offer an interesting middle ground for investors who value diversification, are not interested in picking stocks themselves, and do not want to pay for active management either. ETFs usually have a relatively low management fee only.
Managing your costs
Most of the costs are relative to the portfolio value. This is why it is especially important to bear them in mind when investing in low-risk, low-return assets. Trade commission on that one unnecessary trade can destroy most of the annual result, which is why a long investment horizon, careful portfolio evaluation, and well-thought decisions are important. On the other hand, more aggressive strategies that warrant a higher return per trade can usually justify more tactical, short-term approach.
To wrap up
When buying a security, one has to pay a couple of intermediaries along the way, each of whom serves an important purpose. Their rates are competitive, hence good and bad offers can be found. There are several options for investors looking to give up the burden of managing their portfolios, costs of which increase with the level of customization to the client’s needs.