Posts Tagged ‘commissions’

What Costs More than the Price Tag

Posted on: June 16th, 2010 by

Financial Planning - Rockville, MDHave you ever given much thought to the real cost of an item, compared to the listed retail price?  A perfect example is if you chose to buy a new electronic gadget on credit.  The real cost of the item would be the purchase price and the interest that you have to pay.  The true cost of an item can often go unnoticed and consumers end up paying much more than they bargained for.  Here are a few things that are more expensive than you might think.

Active Trading
You might believe that it would be exciting to become a day-trader because you can get rich by aggressively buying and selling stocks.  All you have to do is buy an investment and sell it for more than you paid.  That sounds pretty easy!  There are even television shows, software and blogs devoted to helping you with your day-trading.  So, should you start actively trading your account in hopes of getting rich?  Not if you want to hold onto your hard-earned money.

The only person who is guaranteed to get rich from your constant buying and selling is your stockbroker.  Brokerage firms absolutely love customers that actively trade their account.  The brokerage firm makes money regardless of whether a stock increases in value or decreases because they charge commissions on every buy and sell order.  You could end up paying thousands of dollars a month in commissions, just for the privilege of trading stocks.  Once you see how quickly these commissions eat up your investment return, you won’t be in such a rush to quit your day job.  This is of course not to say that some don’t realize significant profits through day trading, but commissions build up quickly.

Do you remember the refinancing boom of the 2000s?  Lots of realtors and loan officers were advising clients to take money out of their homes by refinancing.  The theory is that you can get some extra cash by taking the available equity out of your house by extending the years on your payments.  Sounds great right?!  Who couldn’t use some extra cash to pay off credit card debt or refinish the basement?

Not so fast!  Refinancing can cost you more than you think.  Not only are you extending your mortgage obligation for more years; you are also draining the equity out of your home.  As the recent financial crisis showed, housing prices are not guaranteed to increase.  When housing prices drop precipitously as they have over the past few years, you could find yourself owing more money on your new loan than your house is even worth.  There is nothing worse than paying a mortgage on a home that you are upside-down in.

Late Fees
Late fees are like little pests that drain your finances and rob you of financial freedom.  Creditors are famous for adding late fees to any bill paid after the due date.  Late fees may be added to a bill that is one hour late, one day late or one week late.  Credit card companies can charge fees up to $35 for late payments, in addition to the interest.  Most utility companies charge late fees of $5-10.  Cell phone providers, internet carriers, cable and satellite providers will all hit you with at least $5 late fees.  Too many people ignore the detrimental effects of late fees by thinking it is only $5 or $10 bucks.  Add these little late charges together, and you could be losing hundreds of dollars a year.  Over a 30-year time period, you could easily be losing thousands of dollars to late fees.  Imagine what that money could be doing for you if you had placed it in your 401(k).

Credit Card Purchases

Credit card purchases should come with the following cautionary warning: This purchase will cost you more than the price advertised!  Most credit card users end up paying way more than the stated purchase price.  The only exceptions are people that pay their bill in full each month.  Let’s say you bought the new Droid Incredible for $200 on your credit card and your annual interest rate is 18%.  If you don’t pay the balance off immediately than you are going to be paying interest on your phone purchase.  Your awesome new $200 phone purchase can cost you well over $300 if payments are delayed.  Most likely you will not even have the same phone a few years later. You could end up owing hundreds of dollars on a $200 item that you don’t even use anymore.  Small purchases may not appear to be a big deal initially, but over time these little items will end up costing you a whole lot more than you think.

Common Investing Mistakes to Avoid

Posted on: June 14th, 2010 by

Investments - Taxes - Education - Rockville, MDTerrance Odean, a finance professor, has spent his career studying a very specific type of investor: the one who is overconfident, shortsighted and far more likely to snap up a stock at the worst possible moment than to make the kind of contrarian bet that pays off in the long run.  Odean’s specialty: the average investor.  Odean has been studying these types of investors since the 1970’s.  Through this, he has revealed the most common investing mistakes that people tend to make.

First, he looks at overconfidence.  He says that humans seem to be hardwired to expect success and to regard themselves as above average.  In the classroom, he likes to hammer this point home by asking his students to rate their driving abilities.  “Above average” is the virtually unanimous response.  One of the few students who rated herself merely an average driver was, in fact, about to lose her license for having had three accidents in the past year.  In essence, she still rated herself higher than reality.

Odean has concluded that overconfidence permeates the ranks of investors, especially men.  Looking at the trading patterns of 35,000 households over five years, he found that single men’s confidence in their ability to outperform the market prompted them to trade 67% more frequently than did unmarried women.  The payoff for all this activity was predominately negative; the men’s portfolios underperformed those of the less-frenetic women by 1.4 percentage points per year.

Next, he looks to excessive trading.  Odean believes that trying to beat the market is a loser’s game for small investors.  He thinks the “casino” is rigged in favor of larger institutions.  Looking at every trade made on the Taiwan Stock Exchange over four years, Odean found that commissions, taxes, and poor timing of buy and sell decisions drained a collective $32 billion out of the pockets of individual investors.  The winners in the game: middlemen and institutions.  Even when the little guy thinks he’s in the know, he is often clueless about what’s going on behind the scenes.  This is not true for the big guys though.  “For an individual to not believe that he’s at an informational disadvantage when he’s trading against guys from Goldman Sachs is naive,” he says.  “It’s like deciding to play one-on-one with a professional basketball player. You’re going to lose.”

Odean compares the error of “going with the crowd” to children fighting over the same toy.  Investors are often attracted to stocks because others want them.  In fact, individuals are much more likely to buy and sell the 10% of stocks mentioned in the news and ignore the other 90%.  The problem with buying stocks when they’re popular rather than on the basis of fundamental value is that they tend to be expensive and susceptible to changes in investor sentiment.  The day after a stock ranks among top performers, two-thirds of all trades by individual investors are buys.  Over the following month these hot issues underperform the overall market by an average 1.6 percentage points.  Adding salt to the wound, Odean tells us that more often than not the stocks that investors sell outperform the ones they buy.

And finally, Odean talks about stubbornness.  Savvy investors will tend to sell “losers” to book tax losses and offset gains.  Logical as this is, few investors are willing to admit defeat.  That was Odean’s conclusion after analyzing 10,000 discount brokerage accounts over three years.  The exercise revealed that investors are more likely to sell winners and trigger capital gains taxes than to sell their losers and avoid them.

The conclusion:  If you are sure that you are in fact an above-average investor, go ahead and trade like a fiend.  But keep in mind the possibility that you are fooling yourself and would do better buying index funds and focusing on becoming a better driver.