What Does It Cost to Buy a Stock? | Brandon Averill, Justin Dyer | AWM Insights #98
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Episode Summary
Do you know how to buy a stock? How do you open a brokerage account and which account type should you select? Have you made an investment in private equity before?
In this week’s episode, Brandon Averill and Justin Dyer answer these questions in detail along with the expensive costs you may not know about, and what to watch out for to become a savvy investor.
Episode Highlights
(2:14) How do you buy an investment in public markets?
(3:12) To invest, you go and open a brokerage account. Just like opening a checking or savings account.
(4:35) A brokerage account is the most convenient way to buy publicly traded securities.
(5:35) There are many different kinds of accounts and are mostly determined by the tax code.
(7:03) Independent custodians hold the assets of independent RIAs and the separation is important.
(8:00) Robinhood or other discount brokers allow you to trade on your own.
(8:52) How do you actually make an investment?
(9:30) How you go into your account and place a trade to buy.
(10:38) Every stock, bond, ETF, and mutual fund you must know the symbol to be able to buy it.
(11:35) How to buy a stock or ETF.
(12:10) Bonds also have fluctuating market prices you will have to pay.
(13:50) Trading costs in the form of a direct fee or the spread are transaction costs.
(14:50) The bid ask spread is an overlooked cost to investors.
(16:47) The accessibility of public markets is a huge advantage to investors today.
(17:40) How do you make a private investment?
(19:10) Be wary of who is presenting the deal to you and why it made it’s way to you.
(19:40) Private markets consists of private equity, venture capital, hedge funds, and private real estate.
(20:57) Transparency and lack of legal structure can lead to fraud if not careful.
(22:40) Investing into a pool of money with other investors makes you a limited partner.
(23:15) Limited partners give over decision making to the general partners.
(24:00) When money is committed the general partner will make a capital call to the limited partners..
(24:30) Legal costs of creating these investment vehicles and the tax pain point.
(25:30) Compared to an ETF, private investments and their structure are much more complicated.
(26:45) Private investments have minimum net worth requirements or income requirements to qualify.
(27:20) Access to the best private investments is extremely competitive.
(28:12) Hidden costs of being lower down the cap table aren’t always acknowledged.
(29:00) What are the advantages and disadvantages of being with different types of advisory firms. Which ones provide better access?
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+ Read the Transcript
Brandon Averill (00:05):
Hi everyone. I'm Brandon Averill, one of the partners at AWM, where we advise people in creating multi-generational flourishing families, so that we can solve that shirt sleeves to shirt sleeves financial epidemic. And this is a front row seat with AWM's Chief Investment Officer Justin Dyer and myself, as we discuss some of our clients' most pressing financial questions. This is AWM Insights, and let's dive right in.
Brandon Averill (00:33):
Hey, everybody. Welcome back to AWM Insights. Justin, we're going to get back into the basics here. We had the riveting NFT topic last week, probably our most popular episode ever. So maybe we need to bring some current day flavor and it's Super Bowl week, so maybe we can get into that. But we ended right before that NFT session on what are the actual vehicles for investments?
Brandon Averill (00:57):
So we broke down what a mutual fund is, what an ETF is, how do you go buy stocks? And today, we're going to make that transition, we'll get back into the basics. But okay, we identified what those vehicles are, now how do we actually go buy those things? And we'll get into public markets. How almost anybody can go... Probably anybody can go buy them. But then private markets, what does that mean? I want to invest in the next startup company, how do I actually go do that? Where do I do that? So I'll turn it over to you.
Justin Dyer (01:30):
Let me preface and say, hey, we'll try and do our best to keep this as interesting as possible. And I do actually in all seriousness say... I actually had a conversation with my wife about, hey, what we're trying to do and build on the basics with the podcast to start the year. And it's important, right? Anything you're trying to understand, you should always go back to first principles and then really build on it. And so that's what we're trying to do. Again, we'll try and make it as interesting and riveting as possible, and sprinkle in some NFT conversations, or some more timely stuff throughout the series here. But yeah, we'll do our best.
Justin Dyer (02:02):
Anyway, I'll start with the public markets. To your point, that's the most relatable, you hear about them constantly. It's probably impossible to get away from the public markets. If anybody is turning on the news, radio, whatever, getting their news from websites or podcasts, I mean, you're always going to hear, hey, the market's doing this, or the market did X today. The S&P 500, the Dow Jones Industrial Average. So that is the public market, those are indexes, those are measurements of the public market. In most cases, those are subsets. So keep that in mind. We're not going to go too much into index construction today and what an index is. But since I'm talking about that and relating it to what you hear about in the news, just worthwhile to highlight that.
Justin Dyer (02:50):
So really where you start, if you want to go invest in the public markets, in this day and age, you go open a brokerage account. A brokerage account is very similar to a bank account, a savings account. The difference is really the institution in which you're opening an account, right? An account is the same across institutions, one are a bank account, a checking account, savings accounts with a bank obviously. A brokerage account is going to be with a brokerage house, to keep it really simple. There are different types of brokerage houses, discount brokers, prime brokers, blah, blah, blah. But you'd go to a brokerage and open up an account.
Justin Dyer (03:30):
Common names you guys are all probably familiar with, Schwab, TD Ameritrade Fidelity. Those are more on the discount brokerage/institutional side of the business. Robinhood is a big one that's been in the news a lot over the last couple of years, they went public. And actually the SEC just came out recently and said that, that they were looking to overhaul some trading settlement rules, that were really specific... Not specific to Robinhood, but it came up with the big meme-stock frenzy, and what Robinhood had to do and shut down trading in certain securities way back, about a year ago.
Justin Dyer (04:09):
So a brokerage account is where you're going to start. Way back in the day, not to go too far back, you used to be able to go directly and you probably can still today. It just doesn't make a ton of sense to do it, but you could go directly to a company website and basically open an account and buy stock directly with a company if you so chose to do that, there's many reasons why you wouldn't.
Justin Dyer (04:31):
And even further back potentially, you used to get good old stock certificates. If you were trying to buy a stock, you could call up a broker. You'd probably still need a brokerage account in that example in most instances. And you used to get good old fashioned stock certificates, which is a piece of paper that says you own something.
Justin Dyer (04:49):
Nowadays, thank goodness, we don't have to live in that world. It's crazy inefficient, and you can lose things very easily, but just to touch a little bit on history. Then going a step below or a layer deeper within opening your brokerage account, you can have multiple different account types. There's still brokerage accounts that can buy and sell investments or securities to be specific, but it can be... Let's start real high level, it can be a taxable account. Meaning, everything that happens within an account is taxable, basically within the year in which it happens. Or it can be a tax deferred account, those are your 401(k)s, your IRAs.
Justin Dyer (05:30):
It can be a Roth IRA account, which is really a tax-free vehicle. You've paid taxes on the upfront, and you've made a contribution into that. And you don't have to pay taxes ever. A tax deferred account is, you don't pay taxes in the present time, but guess what? Uncle Sam's going to want their money at some point in the future. So they're account types. Those are the basics, right?
Justin Dyer (05:50):
Corporations, companies can have accounts, trusts can have accounts, et cetera, et cetera. So there's pretty much an infinite if you will, list of account types that you can open up, and actually make an investment.
Brandon Averill (06:03):
The thing I'd add too is just, really, you had mentioned some of the discount brokers, so Schwabs, and TD Ameritrades, and Fidelity. And this is where typically you would go... To frame it for people, if you hired an advisor to help kind of oversee your entire financial structure, somebody like AWM Capital, and they're going to help you to set up your accounts with a separate independent custodian, the Schwab, the TD, the Fidelity. So you're not having your assets directly with the advisor that you're picking. And I think that separation is really important.
Brandon Averill (06:42):
Whereas if you're going to the big wirehouses, right? We've talked about this in the past. But if you're going to your Merrill Lynches, Goldman Sachs, Morgan Stanley's, you are effectively doing all of that in one place. And so that is, you're hiring a broker. When you go to hire what most people would consider... I think they still can consider themselves financial advisors. You are hiring a broker in those institutions.
Brandon Averill (07:08):
And so the rules get pretty nuanced and in different... We've talked about this non fiduciaries sitting at the brokerage houses. You get the independent model where you have this separation, you more often than not are held to a fiduciary standard. So I think it's also important to know that you have those. And then you also have, you can go trade on your own. So you can go to the Robinhoods or even some of the discount brokerage houses, open accounts. And then you're relying on your experience and expertise to actually institute whatever investment strategies you're trying to do or what fits within your financial structure.
Brandon Averill (07:45):
So I think it's also good to just note where these accounts can live. All those accounts that you just talked about, Justin, can live in all three environments. And so, yeah, just thought it would be good to mention that's where you can go actually open these or how you open them.
Justin Dyer (08:00):
Yeah, totally. And I think that's something probably worth unpacking down the road, just the industry setup, conflicts, and fiduciary status, and all that good stuff. It's a great point. All right, let's get into the nitty gritty. I'll keep this pretty high level, but how do you actually make an investment? The basic investment you're going to make are what we talked about a couple of weeks back. Buying a mutual fund, buying an ETF, maybe buying a stock, maybe buying an individual bond. Hopefully, you're not doing that because you're listening to this podcast, and really believing in listening to what we have to say.
Justin Dyer (08:33):
But in any case, they're all very similar. It's a pretty similar action, whether it's a mutual fund versus ETF, versus a stock, versus a bond. There are different costs involved in certainly different ways or different trade types. I'm not going to get too much into it, but I'll touch on what that is briefly.
Justin Dyer (08:51):
But essentially, you go into your account, you find where the trading area is. And we obviously manage this whole process internally for our clients, and we have systems and platforms that make it very, very efficient and can do this in a really kind of scalable, efficient, effective, and even lower cost way than most retail investors can do it. But the general process, step-by-step process is pretty dang similar.
Justin Dyer (09:17):
So you go into your account, you find the trading section of whatever platform you're on. And if you're going to buy a mutual fund, I can't recall if we mentioned it the last or a couple of episodes ago. But you don't buy a mutual fund throughout the day. If you're going to buy a mutual fund that day, you go in, you can put the order in to buy or sell it alternatively, and it doesn't execute, it doesn't happen immediately.
Justin Dyer (09:43):
What happens is, a mutual fund actually only trades one time per day. So you say you go in, you follow the fields that are required to have a value. You say, I'm going to buy, I'm going to buy $10,000. I'm going to put in a symbol. So every single mutual fund, ETF or stock and bond, have a unique identifier, a unique symbol that you will need to know if you're going to make that investment. You say you're going to buy it, and you're going to put in $10,000 or whatever amount you're doing. Mutual funds, you can actually put a specific dollar amount in there, versus an ETF, stock, bond, you need to put a share amount. That's one nuance.
Justin Dyer (10:23):
And then you just put buy, you say process, submit. And again, it's not going to happen right away. It's going to happen at the market close, and at a single price, that's the mutual fund aggregates to come up with what's called its net asset value for the day. And then they give you shares of the mutual fund, and you give them cash to make that purchase. If it's the reverse, the reverse thing happens. If you're selling out of a mutual fund, they give you cash and you give your shares back.
Justin Dyer (10:51):
Buying an ETF, buying a stock, very, very similar. Really the nuance there is, instead of putting in a pure dollar amount, you're going to say, hey, I want to buy a 100 shares of an ETF. I want to buy a 100 shares of a stock. That then is multiplied by the current market price of one of those vehicles, to get you to what actual dollar amount you're going to have to pay. So the share price could be wildly different for a 100-share purchase.
Justin Dyer (11:16):
The ETF could be $50 a share. The stock could be $500 a share. You're still buying a 100 shares of something, but the price is way different, and you need to be aware of that. Bonds just by the way they're issued, I'm not going to go into too much here. But generally speaking, you're buying bonds right around what's called the par value. It's not always traded at the par value, there's premiums or discounts, but the par value is roughly a 100, if you want to think about it that way.
Justin Dyer (11:44):
And so when a bond is issued, the par value of that bond is generally speaking, a 100. They take a $100 from you, keeping it really, really simple. And then they're going to pay you interest in return. Once that bond starts to trade in the open market, and if you wanted to go buy that bond, that bond might be 101, it might be 99, but it's going to be pretty close or to around that par value level.
Justin Dyer (12:09):
Now, that doesn't touch on distress debt and things like that, where in some cases, you could be paying 50 cents on the dollar for a bond, because guess what? They've defaulted or they're close to defaulting, but just kind of a side note on that. So the actual action of buying and selling an investment in the public markets, not getting into options, not getting into derivatives or anything esoteric there, it's pretty straightforward. You need to know the amount you want to buy. You need to know the symbol of the vehicle that you're buying or the stock that you're buying. And one thing to keep in mind too, when you're buying ETFs and stocks versus mutual funds, there's trading costs involved with that.
Justin Dyer (12:51):
There are trading costs involved with anything. Mutual funds, typically, you're going to pay a flat trading fee to make that trade, $10, $20, it totally depends on the platform or the brokerage that you're making this trade on. The ETFs and stocks, it's a little bit different. They also used to, or still do have trading fees associated with it, like a flat fee, five bucks, et cetera. Now, a couple of years ago, Schwab actually came out of the gate and pushed their transaction fees to zero. All the other competitors, TD Ameritrade, Fidelity matched them, and brought those absolute trading cost to zero.
Justin Dyer (13:31):
It doesn't mean other platforms still don't charge a trading fee, definitely do. But these big discount brokerage firms now basically charge you absolutely nothing to buy and sell stocks or ETFs, they both fall into that same bucket. It doesn't mean, it's a risk or a free lunch if you will. There still is a bid-ask spread. And this is getting back to that Robinhood piece I cited, that news item I cited, there's still cost inherent to transacting. It's incredibly competitive and costs have come down significantly over the last few decades, so it's benefited the investor.
Justin Dyer (14:08):
But the argument against it somewhat is that, costs have come down at the expense of transparency. I won't go into that too much, but just kind of be aware of that, where there's just topics called payment for order flow, which is really specific to what happened with Robinhood. And it happens with all brokerages by the way, it's not an uncommon practice to have, and it does actually benefit the investor, but again, at the cost of transparency. The price that you see quoted for an ETF or a stock, is not actually 100% correct. That's just the price that the transaction last happened.
Justin Dyer (14:47):
But if you go into buy an ETF or a stock, you're going to see two prices. You're going to see the bid and you're going to see the ask. One of those prices is specific to selling, one of those prices is specific to buying. And if you don't want to transact within that spread, you're actually not going to be able to buy or sell that ETF. If you're not aware of that, you can actually get really taken advantage of. I won't go into too much detail on that. And then Brandon, maybe you want to hit on just other kind of embedded costs, turnover, expense ratios, and whatnot, and then get into private markets.
Brandon Averill (15:20):
Yeah, I think the big thing here is, we definitely got some inside baseball there for everybody listening. And I think hopefully the message you're taking away, and there are additional costs we won't go into them today. But I think with the message you're taking, the beautiful thing about the public markets nowadays, is the accessibility. Anybody and everybody with an internet connection, an address, and a Social Security number in the US, can go open an account, put some money in and access the public markets, which is absolutely fantastic.
Brandon Averill (15:50):
But also hopefully, what you just took away from Justin's explanation is that, it's not as simple as just going and clicking the button and buying yourself a share of a company. If you're doing that, I mean, the people that are trading on much larger volumes are taking advantage of you. Now, it might be at a very small, small level and not that big a deal, but it also could be at a big level. So they make it seem, hey, no transaction fees, is super easy. Go do this X, Y, and Z, but there's still a lot of opportunity to get hurt.
Brandon Averill (16:21):
And I think kind of moving into the private markets, we've talked a lot about the private markets. Again, that relationship exists. You could come to an independent financial firm like AWM, and we're going to build relationships with venture capital firms that run venture capital funds, et cetera. We're going to go help our clients to purchase shares in those funds directly, or even make direct private investments into specific companies. And when you do that, right? It puts a more direct relationship into account. You can't do it on some big mass scale for the most part.
Brandon Averill (17:00):
We hear a lot about venture capital for instance, it's actually a very small market in the comparison of total capital markets. But you can also go to your big wirehouses. So your Goldmans, and Morgan Stanleys, and all these people are going to continue to say like, "Oh, we get you special access, and we get you access to this." And if you just think about the relationship there, not to go too down this path. But if you think about, okay, well, it's actually got to filter through all these channels, what kind of pricing am I getting? What kind of access am I really getting? How watered down is it, if they're sending it to everybody?
Brandon Averill (17:40):
I was at lunch yesterday with a... We've referenced him before, but [inaudible 00:17:45] sold his company for $600 million. He's got a lot of money, but he made the comment again yesterday. He was at one of these big banks and he's like, "I realize I'm not getting the call for this deal. I have 50 million, not 500 million. And where do these..." He actually raised money for another company and saw the inside of what happens in those big brokerage firms, and who gets access to the "good stuff."
Brandon Averill (18:10):
But I think again, kind of going back, there's all kinds of different private markets. I just talked about venture capital, there's private equity that is similar, and venture capital is kind of a subset of private equity. There's real estate. And I'll let you, Justin, get into it a little bit. Like, hey, if I'm going to participate in the private real estate market for instance, there are multitudes of ways that you can actually go and purchase private real estate directly, kind of commingled, et cetera. Brandon Averill (18:41):
But I think the other big thing that we should hit on really quickly is just the cost of that. You talked about the small bid-ask spreads existing in the public markets. I mean, the private markets, holy cow, if you're not keeping an eye on costs, I mean, some of the stuff we see come across our desk is pretty insane. So maybe jump in, kind of give us a little bit more detail, I know I just covered the high level. But when you're looking at the private markets and how to access these things, I think what gets us really nervous when people go just do this willy-nilly, and then also, how do you do it more effectively?
Justin Dyer (19:19):
To the first point, when you go do it willy-nilly, there can be so little transparency and lack of awareness on legal structures, that you can really get taken advantage of. I mean, worst case is that, somebody's saying, hey, I'm making an investment in whatever, a company or a property, why don't you sign up, wire money into my bank account, and I'm going to go purchase this within this entity? And well, guess what? They take all that money and just go run. That is essentially what happens within the private market. And that's why protections need to be there, an awareness, diligence, all that stuff needs to be there.
Justin Dyer (19:58):
There aren't the same regulations and protections of just putting money into a brokerage account with this giant brokerage firm that has compliance, is audited, et cetera, et cetera, all that good stuff. But the basic setup is, you're going to become an investor in a legal entity, an LLC, limited liability partnership, LLP, those are very common entity, formations or forms in which these investments could happen. If you're making a direct investment in real estate let's say, maybe that's just owned in your name, higher risk, higher return, right? Concentrated position, you only have one single piece of real estate to worry about there, separate conversation around risk and how we actually think about all this stuff.
Justin Dyer (20:43):
But if you're pooling your assets with others, and going with a fund manager, again, whether it's venture capital, private equity, real estate, you're going to go into one of these entities and become, really the common term is an LP, limited partner within this entity. You have very limited control as a result of that, unless you're what's called the anchor investor, or you're setting the terms of the pool, where, hey, I'm coming in with X amount of the capital you're trying to raise, as a result, I get to dictate some terms.
Justin Dyer (21:18):
That's not always the case. Some bigger VCs, bigger private equity, bigger real estate, they're like, "No, hey, we don't have problems raising money, these are our terms, take it or leave it." Again, trying not to go too down the rabbit hole there. But I think it's important to understand, hey, you're a limited partner. You are delegating control to what's called the general partner or managing member who gets to make the investment calls. And that makes sense, I mean, that's what you're hiring them to do. But as such, you're locking money up for some undetermined amount of time. I mean, they'll give you a range of what they expect ahead of time. And then you have to think about capital commitment.
Justin Dyer (21:58):
There's a difference between capital commitments and then how much you actually have to fund right out of the gate. You could say, hey, I want to commit a million dollars to this investment. And then chances are, the manager, the general partners are only going to start to call roughly kind of rule of thumb is 20 to 25% per year, over say a four-year deployment cycle. So a commitment is going to be the million bucks, and then you're going to have to come up with the actual cash when capital is called. And that's going to be roughly, again, on kind of a quarter of your commitment per year basis.
Justin Dyer (22:31):
And Brandon, I think you alluded to this, there's a lot of transaction costs on the private side as well. You have to think about legal review. If you're going in with your own entity to potentially have some more protection as well, you have to set up a whole entity, whether that be an LLC or LLP, and there's legal cost to get an operating agreement in place. You have to make filings with whatever state you're going to go into.
Justin Dyer (22:57):
And then because of the entity type, you have taxes that you have to file each and every year that are specific to that entity. So one big pain point you kind of hear commonly within private markets is, "Oh yeah, I have five different investments in different private vehicles. Each one gives us a K-1, and then that flows over to your tax return, et cetera, et cetera." So there's a lot more complexity in getting an investment into place within the private markets.
Justin Dyer (23:23):
There's some interesting technologies, there's sidebar that we've looked at and even participated in, to make the process more efficient. But relative to going and buying an ETF, it's mind boggling kind of how different those two things are, and for good reason. There's good reason for it. And kind of one of the reasons why you expect a greater return in the private markets. But you can go buy an ETF for a zero transaction fee. There's that bid-ask spread we talked about, and there's something called an expense ratio there, but it's minuscule compared to potential transaction costs, the time it takes to get an investment going within the private markets. So I'll leave it there, and we can go further down the road.
Brandon Averill (24:09):
No, I think that's fantastic. And I think to just kind of paint the picture of the differences. We said public market is accessible for anybody and everybody, right? Everybody can log on to the internet and get access. The private market's totally different. Yes, everybody has access to go start their own business. I think everybody would understand the risks involved with that, but the SEC and other entities have put regulations in place to protect most people. And so your access levels, if you are a company raising venture capital money for instance, there's all these rules. There's the venture capitals who put funds together on minimum net worth, or just different profiles of people that actually are even eligible to have access to this. And this is a fluid environment, they're changing. They're trying to bring those levels down, which is interesting.
Brandon Averill (25:05):
But I think at the end of the day, you can't just go out and invest in Andreessen Horowitz's latest fund, just anybody off the street, right? Its access is limited to people of a certain profile. And so it becomes a lot more difficult, right? And how do you actually access the best of the best? Because everybody has access to public markets like we've talked about, the cost, the actual value of the investments is pretty efficient because they reflect all available information, everybody has access to the information. Private side, it's all super limited, right?
Brandon Averill (25:43):
And so, Just, I guess, brings on that word of caution. Whenever you have limited access to things, you have to think about who else has limited access, who's getting the access, where am I in my investor profile and knowledge compared to somebody else that may have access?
Brandon Averill (26:01):
And I think those bring out the inherent costs that you don't realize, you talked about the hard costs, Justin, the legal, and the accounting and all that type of stuff. But what about the cost of not realizing that you're lower down on a cap table? To your point, the anchor investor has better terms than you, and you think you're getting access to this fantastic opportunity, but don't realize that you're at such a disadvantage because you just didn't know.
Brandon Averill (26:26):
So it really is a much more difficult environment to navigate on the private side. Anyways, we've obviously rambled on, but we've gotten some super detailed stuff, which I think is fantastic, we love doing that here. But we'll wrap it up for today. And then next week, we'll certainly get back into the basics here, continue down this path.
Brandon Averill (26:48):
We'll talk probably a little bit more about... We talked about where you can go buy these things. And I think it's getting about that time where we need to dig in, Justin, to okay, what are the pluses and minuses of going to these different places to help you as the investor access different investments, whether it's to a big brokerage house, and you want them, the Goldmans, and the Morgans, and the Merrills. Like what's the benefit of being there, and potentially, what are the disadvantages? What are the advantages and disadvantages to being with an independent. And we'll talk about both on the public and private side.
Brandon Averill (27:24):
But we'll wrap up this week, head over to AWMInsights.com, some downloadable resources for you. That's where you can also drop us a note, let us know how we did on NFTs last week, or let us know if you want to continue down this path of the basics here. But until next time, own your wealth, make an impact and always be a pro.
Speaker 3 (27:51): The information in this podcast is educational and general in nature, and does not take into consideration the listener's personal circumstances. Therefore, it is not intended to be a substitute for specific, individualized, financial, legal, or tax advice. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a final decision.