The cost to buy, sell and hold investments has generally fallen over recent decades. The advent of the internet has slashed commission costs on the purchase of individual stocks, while many fund managers have sought to reduce fees on their products.
However, it is still possible to give up a surprisingly large proportion of returns over the long run to the cost of buying, selling and holding investments. For example, an individual who invests $10,000 in an actively managed fund that tries to outperform the stock market in return for a 1.5% annual fee could end up with an investment of $51,000 after 20 years, assuming a 10% annualized return.
Meanwhile, another investor who pays just 0.5% in annual fees could have a holding valued at $61,000 over the same period, assuming the same 10% annualized return. This equates to a holding that is around 20% greater than an investor who pays 1.5% in annual fees.
Buffett’s view
Indeed, Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) Chairman Warren Buffett (Trades, Portfolio) has previously discussed the importance of avoiding excessive fees when investing.
“If returns are going to be 7% or 8% and you're paying 1% for fees, that makes an enormous difference in how much money you're going to have in retirement,” he said.
Arguably, many investors underestimate the impact of excessive fees. Indeed, a 1% or similar fee sounds minimal at first glance. However, just as investment returns are compounded, the monetary value of a 1%, or similar, fee will rise as a portfolio’s value increases. Therefore, it is logical to develop a strategy that either uses cheaper actively managed funds, passive funds or seeks to buy individual companies from across the stock market.
Reducing the cost of investing
Regardless, even avoiding expensive funds and buying individual shares can still lead to high costs. Many investors buy and sell frequently, which can lead to high commission charges in the long run.
As such, being less active could be a simple approach to reduce the cost of investing. Share-dealing commission and upfront fund charges have fallen in recent years, but can add up over the long run. Investors who adopt a buy-and-hold approach may end up with lower costs and, ultimately, larger portfolios.
A buy-and-hold approach may also provide the time required for individual companies to deliver on their potential. Business strategies, the impact of new management teams and the introduction of new technology or products can take many years to have an impact on a firm’s bottom line. Moreover, it can take even longer for investor sentiment to improve and drive a stock’s price higher.
Furthermore, less frequent buying and selling activity can prove to be a more tax efficient means of managing capital. Although every investor’s tax situation is different, a buy-and-hold strategy may produce a larger portfolio that equates to higher dividends in the long run.
