4. Designing a cheap operation, and where to go next

Costs 6: The full bill

This is the end of the course on the real cost of investing, and the right place to take stock of what you now have, what you do not have yet, and where to get what is missing.

What you have after six levels

• The explicit costs (level 1): commissions, custody, currency conversion and the TER, and why a few tenths of a point repeated over thirty years stop being tenths of a point.
• The invisible costs (level 2): the spread, slippage, market impact, and the fact that every strategy has a capacity beyond which it stops working.
• Where your order ends up (level 3): how a broker advertising zero commissions makes money, what payment for order flow is, and why execution quality is a cost even though it appears on no invoice.
• The wrapper (level 4): funds against ETFs, physical and synthetic replication, tracking difference, and the products whose cost is designed not to be obvious.
• The tax side (level 5): deferral, offsetting losses, foreign withholding, and why when you are taxed matters as much as the rate.
• And this level: the full bill, turnover as a multiplier, and the backtest as the place where these errors dress themselves up as return.

The one component of your return you know in advance

Your portfolio's future return is uncertain: you can estimate it, not know it. Cost, on the other hand, is known with reasonable precision before you start, and it is the only variable in the equation whose sign is guaranteed. John Bogle built his entire argument on that asymmetry: the investor does not control what the market does, but he controls entirely how much he pays to take part in it, and a tenth of a point saved is a tenth of a point earned with certainty.

Charles Ellis took it a step further: in a game where the average gross edge is small and hard to sustain, the winner is whoever makes fewer errors and pays fewer tolls, not whoever gets more calls right. This is not an invitation to passivity or a verdict on active management; it is a description of where the reliable margin lies.

Criteria to keep an operation from eating its own return

These are not investment advice or recommendations about what to buy. They are design criteria, applicable to any strategy:

• Work out your bill once a year, in euros and in percentage points. Without that figure, any discussion about costs is an opinion.
• Compare the cost against the expected return, never against the portfolio. 1% of the portfolio sounds like nothing; against an expectation of 6.5% it is a sixth of everything you hope to make.
• Treat turnover as a decision, not a consequence. Every full round trip has to justify itself against its cost. If your average trade does not comfortably beat the round-trip cost, the trade does not exist.
• Keep an eye on the two costs that are most underestimated: the minimum commission in small accounts with many positions, and currency conversion when you trade outside the euro. Both are fixed by choosing well, not by getting more calls right.
• Sort out your tax decisions before you need them. Deferral and the offsetting of losses are among the few things that improve your result without demanding any forecast about the market.
• Subtract costs from the very first version of any backtest, and always work out its break-even cost. Adding them at the end, once you have fallen in love with the result, does not work.
• Be suspicious of any product whose cost you cannot state in one sentence. If it takes thirty pages to find out what you are being charged, that opacity is part of the price.

What you do not have yet

With this course you can audit a portfolio and rule out most bad ideas for reasons you can justify. What you still cannot do is decide whether a difference in results between two alternatives is real or falls within the range of chance, tell luck from skill in a track record, build a historical test of your own that will not lie to you, or obtain and clean the data needed to do it. That is in the tracks that follow.

Where to go next within the academy

• The easy tracks, without a line of code. The market theory one explains what a share really is, how the order book works and how to read a company; it is the natural companion to this course, because it explains the asset you are buying. The macro one explains the floor above: rates, inflation, central banks, the cycle and credit, which is to say the environment that decides what works and for how long.
• The intermediate track: mathematics and statistics. Here the warnings in this course become measurable. Distributions and fat tails, correlation, significance and multiple testing, out-of-sample validation and regression. It is where 'this result might be a coincidence' goes from a hunch to a calculated number.
• The three hard tracks. Technical skills and Python starts from no prior knowledge and ends with you downloading data, cleaning it, building a historical testing engine that avoids look-ahead and survivorship bias, and connecting to a broker; there cost stops being a warning in prose and becomes a parameter you can vary until you see the level at which your strategy stops making sense. Data and production deals with obtaining information you can trust and with getting the system to trade on its own every morning. And expectations and edge does not carry a single line of code, because it is hard by demand rather than by programming: what is already priced in and where there is room to disagree with it.

A warning that is not a formality

All of this material is education, not financial or tax advice. Nothing you have read is a recommendation to buy or sell any asset or to take out any product, and it is not tailored to your situation, your objectives, your horizon or your tolerance for risk. The figures in the examples are stated assumptions, chosen to illustrate a method of calculation, and they do not reflect the fee schedule of any particular firm, nor the tax treatment applicable to your case, which depends on your country and your personal circumstances. Investing carries a risk of loss, including the total loss of your capital. If you are going to make decisions with real money, do so on the basis of your own analysis and, if you need it, with a professional authorized to provide it.