Issue 16

11/15/04

The High Cost of Commissions

Issue #16 - The High Cost of Commissions

1. Outperforming The Markets With The IWM Index
2. The High Cost of Commissions

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Dear Friends,

Today I've decided to show you just how much commissions
really cost you as an investor. While all the examples I use
are for investors who are trading stocks in online accounts
don't think that just because you have all your money in
mutual funds that you never touch, that you have it any
cheaper.

Research presented in John Mauldin's book that I refer to
specifically states that mutual funds can charge between
1-3% annually and that's not counting the cost of buying or
selling the fund. If you are a wealthy investor and have
hundreds of thousands of dollars, or more invested in a
managed account or a hedge fund, you could quite easily be
paying 20% of your profits, in addition to the regular 1-3%
annually.

Read on to see why I continue to use and recommend
BuyandHold as the brokerage account for the small investor.
My opinion on this won't change anytime soon, in spite of
new information that I reveal at the very end of today's
issue.

First up however, is an update on the IWM Index in light of
how well the markets have been doing since the election.
First introduced on October 18th, I think you'll find the
results so far to be quite impressive.

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Outperforming The Markets With The IWM Index

Back on Oct. 18th, just 4 weeks ago, I introduced the IWM
Index to track the ongoing results of the Investing With Mom
model portfolio. This Index is 100% based on my Mom's
portfolio that I manage on her behalf and includes every one
of the stocks recommended in the Advisory newsletter.

Well, today, Mon. Nov. 15th, we marked a milestone, because
for the first time the IWM Index broke through the 2000
barrier. Quite an accomplishment, considering it is based on
a starting value of 1500 and a starting date of Oct. 1st,
2003.

However, since I've only been publishing my recommendations
on the website from June 11th, that is how far back I go
when comparing our results to the S&P 500, the Nasdaq and
the Dow Jones Industrial Average.

When I first introduced the IWM Index, the total returns for
the 3 major indices were negative from June 14th, through
Oct. 18th, but since the election all 3 indices have been
going like gangbusters. So I've updated the numbers and I'm
publishing them here, so that once again, you can see how
well we've been doing recently.

. . . . . . . . . . . . . . . . total . . annualized
Index . . . .6/14 . .11/15. . .returns. . . returns
S & P 500 . .1125 . . 1184. . . 5.24% . . . 12.43%
NASDAQ. . . .1970 . . 2094. . . 6.29% . . . 14.92%
Dow Jones. .10335 . .10550. . . 2.08% . . . 4.93%
IWM Index . .1712 . . 2016. . .17.71% . . .42.26%

total
Index 10/18 11/15 returns
S & P 500 1114 1184 6.28%
NASDAQ 1936 2094 8.16%
Dow Jones 9956 10550 5.97%
IWM Index 1861 2016 8.33%

As you can see, while all 3 of the major indices have
exhibited extraordinary turnarounds in the last 28 days,
they still trail our model portfolio, the IWM Index by
enormous levels. Additionally, you will see that even
though we've outperformed the Nasdaq, it has been by a very
slim margin over the last 28 days.

However, once that margin is taken over the course of a full
year, that 0.17% will come to over 2.2%, and as you will
discover in today's discussion on commissions, that could be
a significant portion of your costs for the year.

What I find to be the most telling part is that while the
IWM Index has created excellent returns over the last 5
months, we have done so with 4 stocks dropping over 34% and
a 5th tumbling over 20%, all of which is publicly available
on our portfolio page.

I can't say that all my recommendations will always go up,
but I can honestly say that both of the new recommendations
made to Advisory subscribers since I launched the IWM Index
are up. The first is only up 1.2% over the last 25 days,
but if you buy it before Dec. 7th, depending on your broker,
you'll get the 4th quarter dividend which will amount to
another 1.2% at the stock's current price.

The second stock however, is up 15% over the same 25 days.
Because it is an international stock 2.9% of the 15% is due
to the currency's appreciation against the dollar, which
means that the stock itself is only up 12.1% in just 25
days! Not bad for a low-risk, high-yield stock that's also
giving us currency appreciation while the dollar continues
to tank.

Currently most of my attention is centered on the research
necessary to whichever stocks become my December
recommendations. As I've said before I'm focused on finding
excellent opportunities so that anyone, no matter how
small their portfolio, can make money. All I ask is that you
subscribe to the Advisory Newsletter, which, as I mentioned
in a recent issue of this newsletter, is on sale until my
Mom's 65th birthday, Dec. 12th. If you go to the link, just
enter the discount code OPTIN and you'll be paying just
$64/annually, or about 20% off the regular cost of a
subscription.

In addition, over the course of the first 2 years, you will
receive several bonuses that are worth in excess of $4000.
Thus before you ever invest your hard earned cash in one of
my recommendations, you will be getting a 2 year return of
2531.6%, just on the cost of your subscription!

Just go here, to view all the amazing bonuses you receive.

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The High Cost of Commissions

Today I want to discuss commissions and their effect on your
portfolio. As is evidenced by my previous newsletters, the
bulk of my trading occurs in an account at BuyandHold.com.
However, I have also opened accounts in the past at E-Trade
and at OptionsXpress.com, both of which are excellent
discount brokerages, but I do not use either of them on a
regular basis.

Before I go any further, let me also explain that I do not
currently receive any incentive to discuss or recommend any
brokerage. If that ever changes, I will inform you before I
make any recommendation.

To establish a benchmark in our discussion of commissions,
let's consider what John Mauldin states on pages 74-76 of
his excellent book Bull's Eye Investing. I have quoted Mr.
Mauldin before and highly recommend his book. After going
through a thorough discussion of all cost factors, Mr.
Mauldin states that we can conservatively place commissions,
slippage, bid/ask spreads and other costs at 2% of your
investment dollar, annually. I would respectfully suggest
that if you are invested in mutual funds, you could quite
easily be paying more, but for this discussion we will stick
with 2%.

Let's also discuss the number of trades made on a monthly
basis, as that will have an enormous effect on the level of
commissions you will pay.

For the sake of this discussion, let's assume that you fall
into one of 2 categories, active and passive. The active
investor will make 1 trade per day the market is open, or 20
trades/month. Whereas the passive investor will only make 5
trades/month, or about 1+ per week.

For the purposes of this discussion, neither of our model
investors is a pattern day trader, as defined by the SEC and
the IRS.

Both investors would have the same commission costs at
BuyandHold, because if you are making 5 or more trades per
month, you should be paying for the unlimited trading option
at $14.99/month. This means that your total annual
commission costs will come to just $179.88 per year. If this
were just 2% of your portfolio, then the total value of your
BuyandHold account would be at least $9000. Not much for
some of you, but there are hundreds of thousands of people
in the US who only have a few thousand dollars, or even
less, available to invest.

If we were to open an E-Trade account, we would quickly
discover that the advertised rate of $9.99 is only available
to "power" investors, or those who trade a minimum of 9
times per month. All the rest of you would be left out in
the cold, with their regular rate of $19.99/trade. Thus only
our active trader would receive the benefits of $9.99
commissions and even so, our active trader would still end
up paying $2397.60 over the course of a year! I hope you
have over $120,000 in your E-Trade account, because
otherwise you'll be paying more than just 2% in commissions.

Our passive trader will only pay $1199.40 in commissions at
E-Trade, significantly better, but still requiring an
account balance greater than $60,000 if you wish to keep
your commissions costs under 2%.

Let us also consider an account at optionsXpress, an
excellent choice for anyone considering options trading, but
stock trades are still going to cost you $14.95. Which means
that our active and passive investors will pay $3588 and
$897 respectively for the entire year's commissions. Not bad
for the passive investor when compared to E-Trade, but using
our benchmark of 2% costs you'd need to have $179,400 in
your account if you were to fall under our active investor
category. Passive investors would still need to have nearly
$45,000 to beat our benchmark of 2% costs.

Finally, for good measure let's throw Scottrade.com into the
mix, especially since they advertise $7 per trade. That is
unless you want to buy a Nasdaq listed stock, then you pay
an extra $5, just for the privilege.

Since the Investing With Mom portfolio only includes 4
Nasdaq listed stocks, out of 15, we will use the same ratio
when creating our costs.

For our average active investor, Scottrade will only charge
$2000 for a year's worth of trades. This means that with our
2% cost basis, our active investor needs to have $100,000 in
the portfolio.

Our passive investor on the other hand will only pay about
$500, far better than E-Trade or optionsXpress, as this
would put our portfolio at just $25,000.

Why do I go through all these numbers? Is it because I want
to discourage you with the costs of investing? No, I want to
inform you that a.) you don't have to pay exorbitant
commissions if you don't want to and b.) if you're not
getting a good return on your investments, then maybe you
need to look at safe ways of boosting your returns.

Obviously commissions are one of the ways you can boost
your returns and if it takes switching to another broker
to do so, then you should do it. After all, the longer you
stay with a high priced broker, who's going broke faster?

Dividends can also help, but if you're only invested in the
S&P 500, then you'll only get about a 1.57% dividend yield.
Right now the Investing With Mom portfolio has just 7 stocks
paying dividends, but the average yield is 2.2% when you
consider all 15 stocks. If you were to just invest in the 7
dividend paying stocks in our model portfolio, you would
boost your dividend yield to 4.7%.

Even more importantly, you would also find that none of
those 7 stocks are down since I recommended them to you! In
fact, they are up on average 24% since the launch of
Investing With Mom with just one of the 7 up by less than
14%.

Commissions can definitely take a chunk out of your
portfolio, but by being judicious with your investments you
can minimize their effect. As small investors, we cannot
settle for whatever Wall St. tells is in our best interests
as that is the fastest way to lose everything.

Before I let you go, let me share one more investment
website, FreeTrade.com, which just happens to be a division
of Ameritrade. I'm still researching them, as I only
discovered them this past weekend, but they claim to be able
to give you commission free trades.

The unfortunate drawback for most investors is that they
require a minimum account balance of $5000 and that you be
an "experienced" online trader. The reason being that they
apparently have next to nothing in terms of customer
contact. In fact, the only way you can contact a customer
service rep is through a single e-mail address.

They have no phone numbers, broker assistance or offices to
provide any additional help, so I am definitely not
recommending them at this time.

However, I will admit that the idea of commission free
trades definitely intrigues me and as I learn more about
them, I will keep you all informed. In the meantime, $180
for all the trades I want to make in a year is good enough
for me, so I think I'll stick with BuyandHold, for now.

Investments good for my mom and you,
Andy Prior