Submitted by Steve Selengut
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Commissions are no Big Deal... Period - Part 2
For most stock purchases, the costs are up front and visible. For most Bond, and new issue purchases, the commissions are hidden from the investor, as they are with all Mutual Fund and Insurance/Annuity products. Still, all of the acquisition costs of an investment are included in the Cost Basis of the security, and it is this Cost Basis that you should be using to establish your selling targets. As every eighth grader knows, x% of a big number exceeds x% of a smaller number every time, and as experienced investors will tell you, you must have reasonable selling targets if you hope to gain from investing in securities.
If you are managing the investment enterprise properly, your variable costs will move ever higher while your fixed costs remain relatively constant. Understand? As the portfolio grows from income generation and from profit taking, the commission expenses will grow because there will be more things to do more frequently.
- But, you need to replenish and increase inventory if you want growth, and so long as you maintain your profit margin at a reasonable level, service can be more important than the commission rate. A Flat Fee arrangement in an actively traded account can be visually and emotionally effective... but economically, it just ain't so!
Much to your surprise, your realized profits will probably increase at a higher rate than the increase in your variable costs... at least in dollar terms. Could it be true that: if commissions are a function of profitable sales, paying more in total commissions means more profits in the portfolio? And is the payment of more taxes because of increased profits really such a problem? Yes, and No.
All too often, commission avoidance and tax reduction issues are allowed to Wag the Dog, causing millions of unrealized profit dollars to hit the books next year as realized losses. In The Brainwashing of the American Investor, I’ve illustrated how (in a percentage-target trading environment) investors who pay higher commissions actually make more money, in dollar terms, than their frugal discounterparts [sic]. The Math is simple; 10% of a larger number is a larger number, period. But it just plainly should not be an issue at all. And, if it were really as big a deal as it is purported to be, there just wouldn’t be any full service/high commission brokers, would there?
As with most things in life, if it's free, or really cheap, it's probably worth just what you've paid for it.
In investing, fixed costs are minimal unless you go out of your way to increase them by adopting some form of commission replacement arrangement. A management person responsible for directing your portfolio is always a fixed expense, and the fee charged generally moves lower as the account relationship grows. Many Wall Street firms offer arrangements called Wrap or Managed Accounts.
Wrap or Managed Accounts combine commissions and management fees into one charge.
- Where true Individual portfolio construction and management is involved, investors should have the option of choosing to pay commissions viewed as a variable cost, trade by trade, OR as a combined fee that could significantly reduce commission expenses... most of the time. The higher the percentage of income securities in the portfolio, the lower the flat fee would have to be to reduce overall transaction expenses.
- Fixed income investing is much like furnishing a home with durable goods… there should be very low fixed expense and almost no variable costs at all. BIG BUT, if you are using tradable securities (CEFs, Preferred Stocks, etc.), go for the Flat Fee during the downward cycle of interest rates, and straight commissions when rates are rising. Ya follow? (But this has to be fair to all concerned parties.)
- Equity portfolio investing is more like running an active retail business… the more (profitable) turnover, the better. Most retailers have a standard mark-up policy, and most understand the turnover issue. The last thing that a retailer, or any businessperson, wants to see is a higher inventory market value from quarter to quarter! [Read that again and think a minute.]
- Higher sales numbers are the key issue, and turnover is what you should want your Equity Portfolio to produce. If the product isn't selling, in the Investment Portfolio World, it means that the portfolio Working Capital isn't growing.
- Focus on the profits, not on the cost of obtaining them. I know this sounds flawed right now, but it won't once you've gained some experience.
- Properly directed variable expenses are the ideal fertilizer for growing sales, and without sales, there are no profits. And, in equities, if there are no realized profits, why bother?
Click for Details --> Commissions - Part 3
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Steve Selengut is registered as an investment adviser representative. His assessments and opinions are purely his own. None of the information presented here should be construed as an endorsement of any business entity; the information is only intended to be educational and thought provoking.
Risk Management: Income, 401k, and IRA Programs
Take a free tour of a professional investment managers' private SEP IRA program during ten years surrounding the financial crisis:
In developing the investment plan, personal financial goals, objectives, time frames, and future income requirements should all be considered. A first step would be to assure that small portfolios (under $50,000) are at least 50% income focused.
At the $100,000 level, between 30% and 40% income focused is fine, but above age 50, the income focus allocation needs to be no less than 40%... and it could increase in 10% increments every five years.
The "Income Bucket" of the Asset Allocation is itself a portfolio risk minimization tool, and when combined with an "Equity Bucket" that includes only IGVSI companies, it becomes a very powerful risk regulator over the life of the portfolio.
Other Risk Minimizers include: "Working Capital Model" based Asset Allocation, fundamental quality based selection criteria, diversification and income production rules, and profit taking guidelines for all securities,
Dealing with changes in the Investment Environment productively involves a market/interest rate/economic cycle appreciation, as has evolved in the Market Cycle Investment Management (MCIM) methodology. Investors must formulate realistic expectations about investment securities--- by class and by type. This will help them deal more effectively with short term events, disruptions and dislocations.
Over the past twenty years, the market has transitioned into a "passive", more products than ever before, environment on the equity side... while income purpose investing has actually become much easier in the right vehicles. MCIM relies on income closed end funds to power our programs.
To illustrate just how powerful the combination of highest quality equities plus long term closed end funds has been during this time... we have provided an audio PowerPoint that illustrates the development of a Self Directed IRA portfolio from 2004 through 2014.
Throughout the years surrounding the "Financial Crisis", Annual income nearly tripled from $8,400 to $23,400 and Working Capital grew 80% $198,000 to $356,000.
Total income is 6.5% of capital and more than covers the RMD.
Managing income purpose securities requires price volatility understanding and disciplined income reinvestment protocals. "Total realized return" (emphasis on the realized) and compound earnings growth are the key elements. All forms of income secuities are liquid when dealt with in Closed End Funds.
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|Please read this disclaimer:|
Steve Selengut is registered as an investment advisor representative. His assessments and opinions are purely his own and do not represent the views of any other entity. None of his commentary is or should be considered either investment advice or a solicitation of business. Anyone seeking individualized investment advice should contact a qualified investment adviser. None of the information presented in this article is intended to be or should be construed as an endorsement of any entity or organization. The reader should not assume that any strategies, or investments mentioned are any more than illustrations --- they are never recommendations, and others will most certainly disagree with the thoughts presented in the article.