If you discovered your retirement savings were reduced by thousands of dollars, you’d probably be upset! But many people lose significant sums of money from their retirement accounts without realizing it because of overly expensive inefficiencies in the execution of trades.
Every investment trade you make is influenced by how it is executed. Although commissions and fees on trades have been effectively reduced to zero, the way firms execute your trades makes a difference.
Trade inefficiencies result when firms don’t take a thoughtful approach to trade execution. These inefficiencies are usually very small, amounting to pennies per share. However, they add up quickly. If your mutual fund trades millions of shares, those pennies can become a sizable amount of money! Over years of trading, they can significantly subtract from your retirement savings.
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How Trades Are Cleared
Trades are conducted via clearing firms, which specialize in facilitating buying and selling investments, also known as trade orders. When you buy an investment, you get what’s called the “ask price.” When you sell it, you get the “bid price.” The difference between those two prices, usually very small, is called the spread and is one way clearing firms make money.
Some clearing firms are more expensive than others, so the best practice is to shop around for the best price. But many investment advisers don’t! They simply pick a trading custodian and create a trade order, which gets filled by the first offer regardless of how its price compares with other opportunities.
Know Your Adviser’s Strategy
Trading needs to happen in order to rebalance a portfolio and meet target levels of growth each year. The common notion is that if you buy a product and that product is good, you will get a positive return. But how the trade is done also needs to be viewed as a strategic tool to increase return. If you strategically buy a good product that results in a positive return, you will get a better return because you won’t lose some of that return through trade inefficiencies.
This concept is just like bargain-hunting in the non-finance world. Some people always buy from the same store without checking to see if another store sells the same thing for less money. If they shop around, they’ll have more money at the end of the day because they spent less on their shopping trip.
It’s important to understand how your investment adviser handles trades. Some recognize it’s not just the soundness of the investment decision-making that contributes to the client’s return, but also how much it costs to buy or sell those investments. There is a unique platform called UX Wealth Partners that finds the best available trade options for each trade ordered on behalf of clients. It’s available only to registered investment advisers (RIAs), but not all investment advisers use it.
It’s almost impossible for a regular person to determine what inefficiencies exist in trades. So if you have an investment adviser, you need to be proactive in learning how your adviser approaches trading. Ask how the trading is conducted: Is it being done via routine orders to a large custodian, which simply puts trades on the market? Or are trades orchestrated by a platform that is not only focused on executing those trades, but also on making sure clients are getting the best price for the trades?
In short, are they trading methodically, thinking about the pricing and the trade execution?
Over Time, Pennies Become Dollars
Most people spend decades saving for retirement. Over such a long timeframe, even small inefficiencies can add up to large sums of money. By making sure your investment adviser is shopping for the best prices for trade execution, you could avoid losing thousands of dollars unnecessarily.
Work with your financial adviser to make sure all aspects of your strategy are being considered.
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