Jun 20, 2017
How brokerage fees and fractional shares affect dollar cost averaging?
When using dollar-cost averaging (DCA), there are some specific things to keep in mind for the strategy to be effective, such as brokerage fees and fractional ownership of securities.
Like all investment techniques, costs are important, and keeping costs low is a key factor to enhance return and ultimately to increase investor success.
High transaction fees can reduce the amount of money available for monthly investing. For example, using DCA would require 12 trades (1 trade per month) compared to annual lump sum investing that would require only one trade.
Some brokers still charge as much as $15 per trade, so this $180 is money that you could have used to purchase more shares and improve your returns. There is also the issue of maintenance fees.
If a broker charges you 1% to 2% annually to keep your assets under management, this means fees will grow as you invest more money month after month. These rising fees can reduce the amount of funds available for investment, and investors need to consider them.
You also need to think about something called fractional ownership. Although some brokers allow you to owner fractional amounts of shares, most brokers don’t. Instead, they require you to invest in round numbers of shares. The problem with that is it leaves money on the sidelines. If you use our example from “Real Life Example of Dollar-Cost Averaging” we said you purchased a total of 89.19 shares of XBI.
In reality we would have purchased just 86 shares at the available prices, either because the broker did not allow you to purchase fractional amounts of a shares, or you did not have enough money to buy the next higher round number of shares. For example, in the first month instead of buying 16.7 shares, we would only have been able to purchase 16 shares at the price of $59.48 per share. The consequence of this is that we will actually own fewer shares and have more cash in our portfolio than the theoretical ideal allocation.
This remaining cash sits on the sidelines and remains uninvested until we have enough cash to purchase one more share.
In order to effectively apply a dollar-cost strategy, it may be helpful to consider a brokerage firm that allows investors to purchase fractional shares. New brokerage companies like Stash allow investors to purchase fractional shares of ETFs, avoiding the issue of not having enough cash to purchase a full share.
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