My 1st Million At 33 – yes, you can do it too

The commission as a percentage that you pay for transacting stocks comes right off from your bottom line. Most of the time, you don’t get to choose how many percents you want to pay. Answering this percentage question is kind of important for your stock investing. If you treat stock investing like any other business you would run, the stock commissions that you pay are the direct and recurring costs incurred for buying your “merchandises”. Certainly, you want to lower it by as much as possible.

If you assume just an annual return of 10.2% for your stocks (quite a fair number actually), your “merchandises” supposedly can only sell for 10.2% more after 1 year, or 20.4% after 2 years. To carefully control your direct costs, I would say that your costs should be less than 5% of your gross profits, but definitely less than 10% of your gross profits. At 10%, it means that for every 10 transactions, the direct costs eat up all of your profits in 1 transaction. At 5%, it means that for every 20 transactions the direct costs eat up all of your profits in 1 transaction.

To achieve such good business practices, maintaining a lid on your costs, you can either try to lower the percentage that you pay for your stock commission, or you can lengthen your average investment horizon in the hope that you can gain more absolute return per transaction. If you use 5%, and an average holding length of 1.2 years, the commission that you should pay is 10.2% per year * 1.2 years * 5% = 0.612% towards the purchase of your stocks. If you use 10%, and an average holding length of 2 years, the commission that you should pay is 10.2% per year * 2 years * 10% = 4.04%. I don’t think you should use any numbers much bigger than 2 years, because I think that is simply not very realistic. Depending on your parameters, the answer can be ranging from 0.6% to 4%. Obviously, the less you pay, the more potential returns that you could get.

Now, if you use $5 per real-time trade from Izone, and just 1 buy and 1 sell per transaction, you need to pay $10 per transaction. Using 4% for the worst case, at the minimum, your stock transaction size should be at least $250. Personally, my transaction size are bigger. I use 10.2% expected return * 1 year holding period * 3% for better cost control = 0.3%, and at $7 * 2 at FirsTrade or Scottrade or $5 *3 (for 2 buys to reduce entry risk, and 1 sell), my aimed average transaction size comes out to be about $15 / 0.3% = $5000.

Although you can control your targeted “business costs” by increasing your transaction size, the other more important question is really your asset allocation. You should never have over-sized positions in respect to your entire portfolio/networth. Asset allocation is more important than stock picking in my opinion. And limited by factors due to asset allocation and diversification to at least 10 stocks, I will NOT recommend anyone with a portfolio size less than 10 * $5000 = $50K to invest everything in individual stocks. Mutual funds are a MUCH BETTER way to go. There is seldom something that I’m sure about investing, but trust this one on me: if your portfolio size is less than $60K, you should buy at most $10K or 2 to 3 stocks for playing in the stock market to increase your investing experiences. The rest of the money (if not all) should simply go to mutual funds, properly allocated according to your taste for risk & return.

I don’t mean that you won’t succeed if you don’t follow this advice of mine. But chances are that you will not hit home runs, but rather suffer big blows due to your inexperiences & lack of diversification. And if you succeed nevertheless, consider yourself either good or lucky or both.

P.S. You can buy mutual funds commission-free at FirsTrade. Send me an email and I can forward you a referal code (click to see details) for new account bonus of 5 free stock trades (mutual fund trades are $0).