Hidden Costs of Investing
One of the most common mistakes new stock market investors make is failing to fully appreciate the costs involved in investing. While some of the costs can be minimized by selecting the right broker, it is important to understand all costs so that your profits are not reduced, or worse still, turned into losses.
The first thing to consider is the difference between the buying and selling price of the shares. There will always be a difference between the price you can buy for and the price you would receive when you sell.
The difference between the two is known as the spread and this varies by the company and also can vary amongst brokers. Normally the more actively traded stocks have the smallest spread and smaller niche companies have much wider spreads. It is important to factor the spread into your calculations because once you buy a stock it needs to increase by the spread before you are breaking even. When you look at share prices online or in the paper and there is only a single price this is simply the average of the two.
All stockbrokers will charge a commission for buying or selling stocks on your behalf. Commissions are normally a percentage of the total transaction costs and may include stepped rates or a minimum charge. As their operating costs are lower, online brokers tend to have the smaller charges, but you do need to shop around to get the best deals. Remember that you will be charged to both buy and sell stocks so you will be paying commission twice over the course of the deal.
Some stockbrokers also charge a subscription or management charge for holding the shares for you. Again the price varies between brokers and some do not make any charge, although these will normally have higher fees for transactions. In order to work out the best deal for your individual circumstances, you will have to estimate the size and number of transactions you plan to make. It can seem a chore to do this research but many brokers charge a high fee for transferring your holding to a new broker so it pays to get this right first time.
Finally once you have invested in the stock market and made your profit the government will tax you on it. In the USA the tax is straightforward: any income, whether from dividends while you hold the stock or as a capital gain when you sell it, is taxable as income and needs to be declared on your return. Any losses can be used to offset the liability on the gains. Beware not all markets are the same; for example if you buy shares on the London stock exchange there is a tax of 0.5% on all transactions paid to the UK government. If you do plan to invest in overseas markets, it pays to make sure you understand the tax situation of each county first.