Costs of trading shares on the stock exchange

As with so many other things, it is more expensive in Britain to trade in shares than in many other industrialized countries. International comparisons have shown cheaper dealing overseas and fewer complaints about speed and information. Some US brokers also allow small investors a chance to get in on the ground floor by participating in a flotation – what they call there an ‘initial public offering’, or IPO.

Not that the US brokers themselves are universally regarded as kindly philanthropists. There is an old classic book about Wall Street, reprinted regularly over the past 40 years, which comments on the wealth of brokers – it is called Where Are the Customers’ Yachts? Competition and technology may be changing all that.

For all the loud proclamations by the Stock Exchange, small individual holders are still considered a nuisance. Small investors deal in small amounts, which cost just as much to transact as large deals, and the shareholders need elaborate protection from sharks and their own folly because they might sue or generate snide stories in the newspapers, and MPs are likely to kick up a self-interested fuss. However, the market needs the small investor as a counterweight to the unimaginative short- termism of the major institutional holders. Private investors generally also provide a market for smaller companies that are not practical investments for major finance houses.

1. Brokers’ commission

The main cost of dealing comes from the broker’s commission. It varies depending on the type of broker, the amount of work being done, and the size of the deal.

Some charge as little as £5 minimum for dealing, but most brokers charge around £12 to £15 minimum per transaction, though there are brokers going as high as £20 to £25, with a commission on a sliding scale above the minimum, depending on the value of the transaction. An order of £2,500 might cost 1.5 per cent, with the rate falling to 0.75 per cent or sometimes even lower on major deals. There may also be a one-off charge of at least £10 for joining Crest, the Stock Exchange’s electronic registry of share holdings.

A site on the internet called www.fool.co.uk provides a guide to charges of net and telephone brokers. It is not comprehensive and sometimes misses a new service or special offers from some of the participants. It is not unusual for a new entrant to buy a bit of market share by enticing in the passing investor through having an introductory period free of charges. Other online comparison sites suggest other options but all further information needs examination.

2. The spread

There is also the cost of trading. As anyone who has ever tried to sell a second-hand car knows, the price of something is very different depend­ing on whether you are buying or selling. So it is with shares, which is fair enough because the trader needs to eat as well. To make sure the dealer does not starve, this ‘spread’ varies with the risk. So FTSE100 companies like Vodafone, Barclays Bank, British Airways, etc, which have huge market capitalizations, thousands of shareholders and a regular flock of deals every day, would have a relatively narrow spread of under 1 per cent, and some may drop as low as 0.03 per cent; by contrast a tiny company with few shareholders and little trade could have a spread of around 10 per cent.

This makes small companies and their shareholders unhappy because it creates a vicious circle. It is much harder to make a profit from small- company shares because the price has to rise far more to offset the wide spread. That deters all but the hardiest optimists, which therefore means fewer trades in the shares, so reinforcing the wide spread.

3. Advice and portfolio management

If you use a financial adviser to help pick investments, there is obviously a charge for the research and for the expertise in sifting the results to provide the advice.

Some people get a real buzz from organizing their investments. The combination of gambler’s hunch, rational analysis, the prospect of profit, a chance to outsmart the highly paid professionals, and the arcane language of finance combine to produce a fascinating pursuit for some people. That is lovely because it creates the best sort of hobby – the sort that makes money.

Without that confidence, enthusiasm and time, one can still look after the investments but on a more intermittent basis. These are the people who read the City pages of the newspapers and keep up to date with the economic trends; they revalue their investments reasonably regularly and then decide what the best course might be.

As with advice, another option is to subcontract that work and get professional help, not just with building but also with managing a port­folio. Though some independent financial advisers and asset management companies will take on portfolios from £25,000 upwards, many of the companies are reluctant to look at you with less than £50,000 to play with. The fee structure means it would probably not be worth it if they did – and many managers prefer more than £100,000. This can be done through a formal scheme. That brings advice and comment from the stockbroker but still leaves the final decision on buying and selling and the amounts to be put in to the investor.

Another alternative is ‘discretionary’ management, which passes on the preferences and criteria (see Chapters 5 and 6 on how to sort those out) to the broker/manager, who then takes on the job of picking both the stocks and the timing. All this costs money of course – either a flat fee of, say, £1,000 a year, or a percentage of the portfolio managed, which can be 0.5 to 1 per cent depending on size. It goes without saying that you only give this sort of power over your personal finances to someone you trust, but even then keep an eye on them: some stockbrokers have been disciplined for ‘churning’ – continuously buying and selling to generate commission for themselves.

It is up to the individual to decide whether the advice, information and management are worth the cost. For most novices it may well be, but as they get more experienced, learn how to ferret out financial data, and get used to the way it is presented in newspapers and magazines, many decide to strike out alone. Either way, if a financial adviser is look­ing after strategy or portfolio management, do check from time to time whether the investment performance has been better than average, as that could easily have been achieved by investing in a tracker fund or exchange traded fund. Even if it is better, a second calculation should show that the performance was sufficiently better to more than offset the management fees.

4. Tax

After the market-makers, stockbrokers and advisers have taken their fees, the government takes its additional cut from our savings through a tax called stamp duty reserve tax at the rate of 0.5 per cent on the value of every purchase in UK equities of over £1,000 (for UK companies, foreign companies with a British share register, rights and options), even though it was made using income that had already been taxed. For more on taxation, see Chapter 12.

Source: Becket Michael (2014), How the Stock Market Works: A Beginner’s Guide to Investment, Kogan Page; Fifth edition.