Fees

Traditionally, brokerages charged investors a commission when buying and selling stocks/ETF’s/mutual funds. As of 2019, most brokerages stopped charging commissions on trades due to the competitive pressures from Robinhood. Some brokers may charge a percentage when trading penny stocks (stocks less than $5).

ETF’s and mutual funds charge a fee called an expense ratio. This is automatically taken out of the price of the stock. So if you have an ETF that is tracking a hypothetical index that never changes, and the expense ratio is 1%, the price of the ETF would decrease by 1% every year. Expense ratios range from 0.03% to 3%. Mutual funds can also have a fee called a “load” that you have to pay when you buy/sell the fund.

There are 2 types of ETF’s/mutual funds: actively managed and passively managed. Actively managed funds have humans picking the stocks/bonds that comprise the fund and their goal is to beat some benchmark index (like the S&P 500). Passively managed funds (also known as “index funds”) are controlled by computers that are attempting to follow an index - not beat it. A manager of an actively managed fund with a benchmark of the S&P 500 would be trying to pick stocks that beat the S&P 500. A passively managed fund with a benchmark of the S&P 500 would buy the exact same stocks that are in the S&P 500 in the same proportions attempting to replicate the performance of the S&P 500. Actively managed funds typically have much higher fees than passively managed funds. Mutual funds typically have higher fees than ETF’s which are a relatively new invention (1994). There are a number of studies that show that fund managers don’t consistently beat their benchmarks (https://hbr.org/2013/05/just-how-useless-is-the-asset/). Given that actively managed funds have higher fees and they aren’t beating their benchmarks, I typically only invest in passively managed ETF’s.