The costs of investing in stocks can be divided into three categories: explicit costs, implicit costs, and hidden costs.

Explicit Costs

Explicit costs are costs that are reported to you each month; these costs include brokerage commissions and custody fees.

Brokerage commissions: Brokerage commissions are service charges assessed by a broker in return for arranging purchases or sales of financial assets. Commissions vary widely from broker to broker. The commission may be a set amount, such as $15 for a sale or trade, or a percentage of the purchase or sale price, such as seventy-five basis points (0.75 percent): commissions apply to both buying and selling. You should agree on these costs with your broker prior to trading.

Custody fees, or annual fees: Custody fees, or annual fees, are the fees a brokerage house charges for holding stocks, bonds, or mutual funds in your account. These charges may be a minimum amount for stock accounts (for example, $15 per year) or a specific charge per holding (for example, eighteen basis points per security). These fees may also be assessed as a percentage of assets under management (for example, twenty-five basis points).

Implicit Costs

Implicit costs are costs that you may not see until months after you sell a security. The most common implicit cost is taxes. It is critical that you account for taxes when you are valuing the true return of your portfolio. Implicit costs such as taxes are not noted on your monthly report, and most investors do not think about them until they have to pay them. Understand taxes before you begin paying them.

Taxes on capital gains: Capital gains are earned by selling stocks or securities. Short-term capital gains are earned when you sell assets that you owned for less than a year: they are taxed at your marginal tax rate, which includes both your federal and state marginal tax rates. Long-term capital gains are earned when you sell assets that you held for more than one year: they are taxed at 5 to 15 percent, depending on your income level and how long you held the assets. Generally, the longer you hold an asset, the longer you can defer paying taxes on capital gains.

Taxes on stock dividends: Dividends are the returns you get from a company. Previously, stock dividends were taxed at your income rate. However, because of the tax changes in 2003, stock dividends are now taxed at a 15 percent tax rate if you hold the dividends longer than ninety days.

Hidden Costs

In addition to understanding explicit and implicit costs, you should be aware of the hidden costs involved in investing in stocks.

Account transfer fees: These are costs for moving assets in or out of an existing account. Understand the costs before you begin trading.

Account maintenance fees: These are fees for maintaining your account.

Inactivity fees: These are fees for not having any account activity over a certain period of time.

Minimum balance fees: These fees are charged when you fail to maintain the required minimum balance in your account. Make sure you know what the minimum balance on your account is.

Interest on margin loans: This is interest charged on money you borrow to buy securities.

 

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