(lively music)
- Hey everyone, it is Evan here from TheTradeRisk.com.
And in today's video we're gonna be discussing
commissions and taxes, how they're destroying
your trading profits and what you can do
to mitigate the impact of these two very important factors
for all traders, especially the more active traders.
Now, I know it's not a sexy topic,
like trading strategies, indicators, entries,
exits, trade management, stock selection,
all of those good things are much more appealing to us,
as traders who like to tinker
and sort of work on strategies, but I assure you
that if you do not have these two elements in check,
if you don't have your trading operations in check,
this is one of the most costly and expensive
sort of drags, impacts on your trading account.
So, if you're finding this video natively
on YouTube, we do have a blog post.
Everything we're gonna cover is up on thetraderisk.com.
I will link it up right now in the top right hand corner.
So, if you wanna scroll through the article instead,
by all means do that.
And in the description of this video I'm going to put
the time stamps with some of the sections
we're gonna be covering.
So, if you wanna jump around, that's cool too.
Just head to the description.
Sometimes I go on rants and things take a little bit longer,
so feel free to jump around.
You can find that below.
So, without any further, let's jump into our lesson
on commissions and taxes.
Back when I just started trading,
I paid Scottrade $18,364
in commissions.
Now, at the time, my account size was right around $25,000.
So, when we look at that commission cost
verses the account size, we can see that I needed to return
73% on my trading that year just to break even,
just to pay Scottrade the cost
for trading on their platform.
I ended up losing about $3,000 that year
and I thought it was me.
You know, I thought I had to study more,
I needed a new strategy,
I needed to work on my psychology, right?
These are all of the things that we are taught
and we read in books as traders starting out
on how to improve and how to get better.
But, really I was stuck in a situation that was,
had the odds stacked so laughably against me.
There was no way that I was going to be able to
turn a profit in that type of trading environment,
in those operations that I was currently,
sort of going down the path of.
I made over 60% return that year.
Now, granted most of that return was just crazy risk
when I look back at it.
Slinging around options and doing some crazy stuff that,
ya know, I would never, I would just kinda wanna vomit
thinking about some of what was conducted
the early years of trading.
But the point is it could've been a lot worse.
I did, I had a great return all things considered.
It was the cost of commissions that was really killing me.
So, the most overlooked but expensive cost
for traders in commissions.
And again, it's boring conversation for most traders,
especially if you're starting out.
Nobody wants to really talk about, ya know,
these one, two, three, four, five dollar commissions.
They're innocent sounding, right?
How big of an issue can it be?
I'm going to be the next, ya know,
best stock trader in the world who's gonna retire
with yachts and do all this great stuff.
I don't need to worry about these several dollar commissions
per trade, but that's not exactly the case.
So, I recently consulted with a trader
who was basically in an identical situation
to the one I was in years ago.
Looking to actively day trade, paying $7.95 per trade
with an account under $20,000.
There is nothing that I can teach this trader
about strategy, entries, exists, indicators,
anything like that, that is gonna be more important
than getting the trading operations under control.
There is no way that you can be an active trader
paying those types of commission costs with small accounts.
So, here's an example that I wanna run through
to sort of illustrate some of the impact here.
And maybe you can relate to this if you're starting out
or as you think about your trading
that you're doing right now.
So, I want you to meet Johnny the day trader.
Johnny is super excited to start trading.
He wants to be active.
He wants to trade fairly frequently.
And here's some of the stats that we're gonna apply
to Johnny here and we're gonna start to breakdown
just a little bit of basic math
to sort of illustrate the impact here.
But Johnny makes 10 trades per week.
So that's 20 transactions, remember you gotta buy and sell
so there's 20 transactions but it's 10 trades per week.
And he takes partial exits on half of his trades.
So now we're talking an extra five transactions,
so we're up to 25 transactions per week.
And he pays his broker $5.95 per transaction.
Johnny takes two weeks of vacation, no trading.
Good for him.
To get away from the screens.
So that means he trades for a total of 50 weeks per year.
So, let's take a look at the math for Johnny's situation.
25 weekly transactions, 50 weeks in a year.
So he makes a total of 1,250 annual transactions.
When we apply that to the $5.95 commission costs,
we can see Johnny is gonna pay $7,437
out of his pocket to his broker.
Still doing better than I did on my beginning year
when I paid, ya know, $18,000 and change.
But, here's the table to pay attention to now
because most traders don't come into trading with a high,
ya know, six figure account.
Most traders are starting to earn some money on the side
and they want to invest it and trade it to actively grow it.
So, when we look at the account size needed to break even
on $7,437, this is what Johnny's gonna need.
At $5,000, which is a, kind of a standard amount,
that's ya know, many traders start in this business
with a couple thousand dollars, $5,000,
maybe if they're lucky.
You need 149% return.
That's just to break even.
That's before you start paying yourself a dime,
you need 149% return on 5K
and you can go right down this list.
10K, 74%.
20K, 37%.
$50,000 you still need a 15% return
and even a six figure account at 100K,
you still need to earn 7% to break even.
And to give you some context here,
the long term annual growth rate of the S&P 500 is about 7%
so that's how much the stock market,
if you were just a buy in holder to just own the index,
put it away and not look at markets, it grown at ya know,
roughly 7% depending on how you wanna account for inflation.
But think of that against your trading account
because you're not growing at 7%,
you're actually getting negatively compounded 7% against you
year after year after year.
So, here is sort of the next topic here
of how do we handle this?
What do we do?
And it's really getting more profitable by immediately
reducing your commission cost.
It's very simple but very few seem to want to do it
or actually go ahead and get this accomplished.
The solution is simple, right?
How do you do it?
You find a cheaper broker.
And the good news is, the year over year costs
of trading transactions, commission costs,
there in a long-term bear market.
If we look at this chart here and it only goes to the 2000s,
but I can assure you that ever since the 2000s,
really we've actually only kinda accelerated lower in costs.
But you can see here, ever since the 1970s or so,
we've kinda peaked out and commissions are on the decline.
If you're a new trader, if you're just starting out here
in the past year or two and you're kind of
getting your education up to speed,
commissions back in the day would cost
hundreds of dollars per trade.
It was nuts, right?
Nothing like you see here today with $10 or less.
But as we see, $10 or less still adds up
if you're an active trader.
So, the good news here is brokers are cheaper.
So, thanks to Robinhood,
you can even eliminate commission costs altogether.
You know, basically Robinhood was introduced,
I think in 2014 is when they went live,
they have a zero dollar commission cost policy.
And for new traders, if you're just starting out,
I recommend or I strongly suggest,
no direct recommendations here, that traders dip their toes,
get started with Robinhood.
And the reason is because of the chart we looked at before.
Think of Johnny the day trader who wants to start
with a small amount of money and actively trade.
That cannot happen with virtually any broker with a sub,
say $5,000 account, trading several times per week.
Basically cannot happen.
Even if you're one of the most profitable traders
in the world, you are still gonna get eaten alive
by those commissions.
So, Robinhood, like them or hate them, and again,
they don't have all the tools,
they don't have charting software,
they don't have a big suite of indicators,
but if you're starting out and you're trying to get
market experience, you're trying to get skin in the game,
you wanna see how stocks move,
you wanna start to participate in trades
and not get destroyed by commissions,
I think it is financially irresponsible not to be with
Robinhood as you start out.
Now, as you start to get more experience and you need more
tools and you need to do some other things,
then you can graduate to another broker.
But for sure execution standpoint,
I think Robinhood is where you wanna be.
Now, the bottom line is, you know, whether it's $8.95,
$5.95, $2.95, whatever you're paying your broker right now,
you need to think about the value that they're giving you
beyond just the execution.
So, you need to think, is there a cheaper alternative for me
to trade and transact in a cheaper fashion.
Because it will drastically improve your bottom line, if so.
Now, again, if you're a position trader,
if you're an investor, if you're not doing many trades,
then I have no problem if you're paying nine, ya know,
I think it's totally reasonable
to be paying $9.95 per trade.
You like your broker, you've been with the platform,
it does everything you need
and you make a dozen trades per year.
It's water under the bridge that doesn't really
impact your bottom line all that much.
I'm really speaking to, either A,
the traders with smaller accounts
or B, the traders that are very active
or want to be very active making intraday trades
or even a trade every day can add up.
So, think about that, think about the options out there.
I'm not gonna go through a big list
or bring you a table of brokers
'cause they're changing their offerings.
If you do a quick Google search, ya know,
you can certainly check out what the latest offerings
are for brokers.
But it's something that is absolutely worth your time
every year or so to sort of refresh the options out there
and make sure that you're in sort of the best situation,
you have the best operations under control for your trading.
So, our next tier we're gonna start to move into taxes
and get more profitable immediately
by trading in tax-deferred accounts.
Now, before we get into this section
of the thing in the blue box there,
you see the slight disclaimer there,
remember nothing published by The Trade Risk is
financial advice, nor is it tax advice.
So, please consult a CPA.
Review our disclaimer, traderisk.com/disclaimer.
So, make sure you get your personal advice
with a professional that can look at your situation.
I wanna just talk about some high level things
to think about, some concepts.
Everything here is pretty much, ya know,
able to be found pretty easily through Google
and you can dig into it based on
how it relates to your situation.
So, taxes play a potentially even greater role in destroying
your trading account over time,
your trading profits over time.
It's tricky to speak specifics because everyone watching
this is gonna be from different countries,
different tax brackets, income brackets, ages.
There's a lot of variables in the tax structure,
particularity in the U.S.
So, it's tough to talk specifics but, again,
our goal here is to just kinda point you and give you some
things to think about and research for your own situation.
So, before we, ya know, really get started,
let's put a definition to tax deferred accounts.
I'm gonna just read this out here.
"Tax-deferred saving accounts occurs when you use
a specially designed account, or investment option,
that does not require you to claim the investment
income earned inside of the account
every year on your tax return."
So, instead you get to defer this investment and income
until you choose to take a withdrawal
from the tax-deferred savings account
or until you cash in the investment.
Grabbed that from theBalance.com.
So, basically taxes in this type of account are sheltered.
You don't have to report them every single year
at the end of the year and pay your 20%, 30%,
whatever your income tax is.
You can actually kick them off into the next year
and into the next year and into the next year,
until you decide to take those distributions
or cash those in or roll those over in some way
that would trigger a taxable event.
Tax-deferred accounts generally fall under the category
of retirement accounts because they are in place
to help everyone grow in a more reliable fashion
into actually get some savings
for when people are done working.
So, here are, here's a chart of the impact
of taxes over time.
So, that orange line there is a tax-deferred account.
That is an account that is growing year over year
without any withdrawals or tax implications
come the end of the year.
The gray line is a taxable growth account.
So, this assumes that you're going to withdraw money
at the end of every single year on your profits to pay
your taxes, thus reducing your capital each and every
December or January or whenever you would do your taxes.
And for this simulation it's a starting balance of $10,000
with a 15% annual growth rate and a 30% taxable rate.
Just kinda stuck there with some round numbers,
think we can all sorta figure out where we sit
relative to our returns per year and out taxable rates.
But notice the huge, huge, huge difference here
after 10, 20, 30 years.
It makes a tremendous, tremendous difference.
And it goes without saying, ya know,
obviously returns are not gonna be this linear,
you're not gonna always have 15% returns
but it's not really the point here to illustrate a perfect,
you know, ebb and flowing sort of reverting
trading strategy, it's more just interest,
I'm more interested in showing you the impact of taxes
over time, year over year, over a long time horizon.
So, that in itself should hopefully get the gears spinning
and get you thinking about potentially looking at some other
options for your trading accounts.
And we're gonna show you how to do it.
So, tax-deferred accounts, there are benefits and drawbacks.
So, the clear benefit is just the huge return
we just saw, right?
The huge growth return over a long period of time
significantly boost your long-term annual growth rate.
I think that's clear.
And that is, by and large,
the most positive benefit for this type of account.
Another benefit is, you can't touch the funds
without incurring a penalty.
And this is a benefit because it's going to keep you
sort of saving, it's going to keep your investment money
sort of where it belongs is as an investment
and if you see a, ya know, if you're looking to trade in
for that new car and you wanna sort of tap into
your trading account here, you can't quite do it.
It's stuck there and it's sort of a good behavioral
best practice if you're in fact trying to grow your wealth
for a longer term time horizon.
Really enforces discipline.
So, the drawbacks are, there are limitations
to how much you can contribute each year.
You can't sort of just throw in 10 grand,
take out five grand.
You can't put in another three, ya know, you can't just move
cash in and out like you can with a normal, taxable,
margin account or a standard broker account.
There are limitations every single year on how much
you can contribute to these types of accounts.
And you can't supplement your day to day income
with trading in this type of account.
So, for example if you started trading so you could help
pay for your bills, if you wanted to pay the electric bill
or pay the rent every single month,
you're not gonna be able to do it in this type of account
because you can't easily withdraw from tax-deferred accounts
without incurring a penalty.
And if you start incurring that penalty,
then you're really just gonna do more damage.
You might as well just keep it in a taxable account
to begin with.
So, your funds are sort of stuck.
So, ultimately, ya know, in this blue box
in the bottom left, allocations boil down to your goals
and why you got into trading.
If you want to supplement your income,
if you're trying to quit your job to trade,
then tax-deferred accounts of course,
are not gonna be ideal for you.
But if your goal is to grow your wealth and to build
and compound as fast and as much as you can,
the tax-deferred accounts make a ton of sense.
And especially for active traders.
And a little tip there is to diversify between accounts.
I don't think you have to be all in, you don't have to
only trade one type of account,
you can have multiple sort of accounts.
So you have your taxable account where you can withdraw
if you need to pay the bills or get a new car,
upgrade to a new iPhone.
And then you also have your savings which can start to grow
without being impacted by Uncle Sam at the end of the year.
So, that pretty much wraps everything up.
That was the lesson for today.
Beating the markets as an active investor
is difficult enough to do, right?
There's lots of challenges to have a long-term,
consistent growth rate as traders and investors.
And what we're saying here is don't make your life
any harder than it has to be.
Get your commission costs under control,
be strategic with your structures
in which you invest your capital.
And if you look there in the blue box, ya know, chances are,
I've seen it time and time again, you know, the 200 hours
that you're gonna go out and search YouTube for, you know,
optimal trading entries or how to get my indicator,
switching the look back period so I can get
slightly more profitable trade, chances are
all of that work you're gonna do,
I don't mean to sound pessimistic or shoot this down,
'cause I think those are important things to do
is to optimize your strategy, but I think many people
kind of miss the forest and they don't take one hour
or two hours of research per year to make sure
that they're paying the cheap as possible
for their commission cost, calling up their broker
and saying, hey, I've been with you for X years
and I paid you X dollars last year,
how 'bout 20 cents cheaper per trade?
Right?
And I think that is going to impact your profitability
a lot more than many of these other, sort of, activities
or research sort of fields that I see many traders
spending more of their time on.
So, if you enjoyed this lesson, check out more.
Thetraderisk.com/learning-center,
there's a lot more articles.
There's more articles here on YouTube
so in the training education playlist, there's a lot more.
It's not just boring stuff like this.
There are strategy conversations, finding stocks,
all types of things, basically all things trading.
But if you do like this video,
check out some of the other material that we have out there
and any questions, leave a comment below, send me an email
or contact through The Trade Risk website.
I'd love to hear from you.
So, thank you so much for watching and good luck out there.
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