How low costs can drive returns

Investors looking for an advantage may do well to seek out lower expenses on brokerage products.

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Key takeaways

Lower costs can compound over time, creating the potential for significant impact.

Consider cost and value for trades, margin, and other investment products.

Active investors are said always to be looking for an advantage—new information, a new perspective, or a new strategy that can help boost investing returns. There is one place you can get an advantage that comes with certainty—if you pay less to execute your investment strategy, you will improve your bottom line. That’s why taking steps to reduce your fees may be among the easiest and most effective ways to improve your investment performance, particularly for active investors who regularly make changes to their portfolio.

“It pays for investors to seek out value,” says Ram Subramaniam, head of brokerage and investment solutions at Fidelity. “If you can get quality service, research resources, and the trade execution you need for a lower cost, it can help improve your performance and ensure that more of your return ends up in your pocket.”

Fees matter

For investors, saving on investment transactions and products can have a significant impact over time. If you choose to invest the amount you have saved on fees, that gives you more capital to invest, and the potential to compound the savings through your investments.

Consider this hypothetical example. An investor who trades 100 times a year changes brokers to save $5 on each trade, and also get better execution, saving an extra $1.50 per trade through price improvement. Let’s say this investor was trading in a tax-deferred IRA and earning a hypothetical annualized return of 7%. If they reinvested all the savings over 10 years, the savings, and investment returns on those savings, would be worth more than $9,000 before taxes (see chart).

This article looks at a few different types of investment fees to show how they can affect you—but this is just a sampling. You should consider the costs of all your investment products.

Stock commissions

Investors buying and selling individual securities are exposed to commissions and other fees that accompany these transactions, such as the flat per-transaction fee or percentage-of-assets commission they may pay when buying stocks or ETFs.

These fees tend to be small in dollar terms, so you may simply accept them as a cost of investing. But if you trade frequently or tend to trade small amounts, these costs add up and can have a noticeable effect on your investment returns. For example, if you trade 100 times each year, the difference between a $4.95 commission and a $9.95 commission would total $500 annually.

Along with commission amounts, active investors should look for value—that means consider the quality of trade execution. Price improvement is an important consideration for traders. Here's how it works: Brokers will send an order to an exchange, electronic communication network (ECN), or other market for execution. If a sell order executes at a price higher than the best bid listed, or if a buy order executes at a price lower than the best offer listed, it is considered price improvement.

One way to measure price improvement is to focus on the percentage of trades receiving price improvement. But it may be more meaningful to consider the average price improvement per trade, as that statistic reveals the true financial benefit from price improvement. Even if a large percentage of trades are price improved, the average price improvement per trade may be relatively small. It makes sense to consider both the average price improvement per trade and trading commissions when evaluating overall cost.

Options contracts

When you trade options, most brokers apply an additional charge per contract to the standard trade commission. That extra cost may appear small, but even saving a small amount can add up over hundreds or thousands of contracts.

Margin rates

When investing on margin, you borrow money, using your portfolio as collateral, and invest the money you borrowed. The leverage created by the borrowed assets affects your performance either positively or negatively. Costs can play a significant role in these transactions.

You pay interest on the loan, of course—and the higher the interest, the less of any gain you get to keep (or the greater your loss will be). Margin fees often vary based on the loan balance, and the broker. As of February 2017, the lowest retail rates available at major brokerages ranged from 4% to 6.5%.

Bond markups

Bonds aren’t traded on open exchanges the way stocks are, and compared with stock trades, they can have some less transparent charges.

When you buy a bond on the secondary market, some brokers include a “markup” in the selling price —a transaction cost that is the difference between the price a broker-dealer pays for a bond and the price at which it is sold to you. Other dealers, such as Fidelity, display secondary bonds with their prices as they receive them from traders and add a concession to the offer price. With new-issue bonds, the broker’s compensation or fee received for distributing the bonds is included in the face value and paid for by the issuer, so you, the investor, do not pay a separate transaction cost.

Bond markups vary by issue, order size, and broker. The markups can be small amounts, such as 0.1%, or more significant—in some cases more than 2% of a bond’s face value. Making matters tougher for investors is the fact that certain brokers bundle this fee with the quoted bond price—making it hard to evaluate how much you are paying your broker. If these fees are large, they can take a big chunk out of your returns. Say you set up a bond ladder, investing $500,000 across 20 bond issues in $25,000 allotments. Comparing a 1%-per-bond markup with a 0.1%-per-bond ($1-per-bond) markup equates to a saving of $4,500.

"Understanding bond markups and how much you are paying the broker is very important, particularly in today's bond market," says Richard Carter, Fidelity vice president of fixed income products and services. “If you are buying a bond that yields two percent and you’re charged a one percent markup, it could erase a significant portion of your income and total return.”

Mutual funds

Stock mutual funds come in lots of different flavors, including passive index funds and exchange-traded funds (ETFs) that attempt to track a basket of stocks in a particular index, and actively managed funds that attempt to outperform an index. Just as the different funds offer different types of services, so, too, fees can vary widely.

Virtually all mutual funds and ETFs include an annual fee for investment management. They also charge for other services, such as recordkeeping, taxes, legal expenses, accounting, and auditing. Some funds also charge a marketing fee. All these expenses are included in the expense ratio—which is published in the fund’s prospectus.

Typically, index funds and passively-managed ETFs charge lower fees, and attempt to re-create the performance of a benchmark index by holding a basket of stocks. Actively managed funds attempt to perform better than their benchmark through analysis of individual stocks, and ongoing portfolio construction, and may charge higher fees. But even within the universe of actively managed and index funds, there are significant cost differences. Expense ratios may not capture all the costs investors should consider when selecting funds. There are a few costs that are not included in the expense ratio—including sales charges, or “loads,” that are paid when you first buy a fund, which are often used to compensate advisers for their advice. Some funds also charge deferred sales charges and redemption fees.

How much do fees matter? A fund’s expense ratio is subtracted directly from its return, and because costs compound the same way earnings do, even small differences in price can make a big impact over time. At the same time, performance has the potential to more than offset differences in cost—so you should consider expenses within the context of the performance you expect.

Managing the risk of paying too much

Diversification is sometimes described as the only “free lunch” in investing—a way to potentially reduce volatility without necessarily sacrificing returns. However, this is not quite accurate: You can do the same by managing costs. Being mindful of fees and other expenses in your investment process can make a considerable difference in your overall return and in your ability to meet financial goals.

“Investors have to weigh service, strategy, and performance potential along with cost when choosing products and services,” says Subramaniam. “But it makes sense to consider value too—because anything you save on fees can be put to work in achieving your investment goals.”

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Free commission offer applies to online purchases of Fidelity ETFs and select iShares ETFs in a Fidelity brokerage account. Fidelity accounts may require minimum balances. The sale of ETFs is subject to an activity assessment fee (from $0.01 to $0.03 per $1,000 of principal). iShares ETFs and Fidelity ETFs are subject to a short-term trading fee by Fidelity if held less than 30 days.
ETFs are subject to market fluctuation and the risks of their underlying investments. ETFs are subject to management fees and other expenses. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than their NAV, and are not individually redeemed from the fund.
Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read "Characteristics and Risks of Standardized Options”. Supporting documentation for any claims, if applicable, will be furnished upon request.
Minimum concessions of $19.95 apply if traded with a Fidelity representative. For U.S. Treasury purchases traded with a Fidelity representative, a flat charge of $19.95 per trade applies. A $250 maximum applies to all trades, reduced to a $50 maximum for bonds maturing in one year or less. Fixed income trading requires a Fidelity brokerage account with a minimum opening balance of $2,500. Rates are for U.S. dollar–denominated bonds; additional fees and minimums apply for non-dollar bond trades. Other conditions may apply; see Fidelity.com/commissions for details. Please note that concessions may affect the total cost of the transaction and the total, or "effective," yield of your investment. The offering broker, which may be our affiliate National Financial Services LLC, may separately mark up or mark down the price of the security and may realize a trading profit or loss on the transaction.
There is an Options Regulatory Fee from $0.04 to $0.06 per contract, which applies to both option buy and sell transactions. The fee is subject to change.
1. $4.95 commission applies to online U.S. equity trades in a Fidelity retail account only for Fidelity Brokerage Services LLC retail clients. Certain accounts may require a minimum opening balance of $2,500. Sell orders are subject to an activity assessment fee (from $0.01 to $0.03 per $1,000 of principal). Other conditions may apply. See Fidelity.com/commissions for details. Employee equity compensation transactions and accounts managed by advisors or intermediaries through Fidelity Clearing and Custody Solutions are subject to different commission schedules.
2. 4.00% rate available for debt balances over $500,000. Fidelity’s current Base Margin Rate, effective since 12/15/2016, is 6.825%.
Price improvement details provided for certain domestic stock and single-leg option orders entered during market hours after the primary opening, provided there is a National Best Bid and Offer (NBBO) at the time the order is placed. Price improvement details are provided for informational purposes only and are not used for regulatory reporting purposes. See Fidelity.com for more details.
Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.
Investing involves risk, including risk of loss.
In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible.
Diversification/asset allocation does not ensure a profit or guarantee against loss.
Exchange-traded products (ETPs) are subject to market volatility and the risks of their underlying securities, which may include the risks associated with investing in smaller companies, foreign securities, commodities, and fixed income investments. Foreign securities are subject to interest rate, currency exchange rate, economic, and political risk, all of which are magnified in emerging markets. ETPs that target a small universe of securities, such as a specific region or market sector, are generally subject to greater market volatility as well as the specific risks associated with that sector, region, or other focus. ETPs that use derivatives, leverage, or complex investing strategies are subject to additional risks. The return of an index ETP is usually different from that of the index it tracks because of fees, expenses, and tracking error. An ETP may trade at a premium or discount to its net asset value (NAV) (or indicative value, in the case of exchange-traded notes [ETNs]). Each ETP has a unique risk profile that is detailed in its prospectus, offering circular, or similar material, which should be considered carefully when making investment decisions.
The expense ratio is the total annual fund operating expense ratio from the fund’s most recent prospectus.
Margin trading entails greater risk, including but not limited to risk of loss and incurrence of margin interest debt, and is not suitable for all investors. Please assess your financial circumstances and risk tolerance before trading on margin. Margin credit is extended by National Financial Services, Member NYSE, SIPC.
For iShares ETFs, Fidelity receives compensation from the ETF sponsor and/or its affiliates in connection with an exclusive, long-term marketing program that includes promotion of iShares ETFs and inclusion of iShares funds in certain FBS platforms and investment programs. Additional information about the sources, amounts, and terms of compensation is described in the ETF’s prospectus and related documents. Fidelity may add or waive commissions on ETFs without prior notice. BlackRock and iShares are registered trademarks of BlackRock, Inc., and its affiliates.
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Past performance is no guarantee of future results.
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Before investing, consider the funds’ investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.

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