What are transaction costs?
In the financial sector, transaction costs are the costs that an investor has to pay to the custodian bank when buying or selling securities, for example. These transaction costs can include commissions, fees or spreads. Spreads are the difference between the amount of money the trader pays for a security and the amount of money the trader ultimately charges. Different asset classes have different ranges of transaction costs. Transaction costs are one of the most important determinants of net returns.
Generally speaking, transaction costs are the costs incurred when buying or selling a good or service. Among other things, they compensate for the work required to bring a good or service to the market. The costs for real estate transactionsalso include, for example, brokerage commissions and closing costs, such as fees for appraisals. An investment fund, for example, charges an expense ratio for operating the fund, which reduces the amount actually invested. Stamp duty, for example, must also be included in the transaction costs if it is incurred. Transaction costs also include information costs (e.g. the search for suitable business partners), agreement costs (e.g. contract negotiations), settlement costs (e.g. coordination of the purchase or sale) and adjustment costs (e.g. contract amendments).
Areas of application of transaction costs
In economic theory, transaction cost theory is subordinate to institutional economics. As an economic theory, the focus here is on the efficiency of transaction costs. In this context, efficiency means using scarce resources as sparingly as possible.
Transaction cost theory provides explanations for the existence of markets and economic entities. Financial institutions, for example, reduce transaction costs. Savers and borrowers have to communicate with each other in order to conclude transactions. To do this, they need some kind of platform to come together. Communication is a type of transaction cost. The bank acts as an intermediary by linking savings with investments. The bank in turn charges money for this.
The use of the Internet significantly reduces transaction costs. The Internet and telecommunications have also reduced communication barriers. This means that buyers and sellers, as well as savers and borrowers, are less reliant on institutions and agents. A large number of technology start-ups that operate their own websites therefore represent major competition for insurance companies, banks, real estate agentsand car sellers, for example. However, obtaining information online can be very time-consuming. In addition, transaction costs are not always transparent, especially for complex financial products. In the case of financial investments, the level of transaction costs is decisive for an investor’s return. A good asset manager can help you make many decisions and reduce transaction costs.
Transaction costs can be useful for companies when making internal decisions. For example, they can be used to compare whether the costs of producing a good or service internally are more favorable than purchasing the good or service externally (make or buy decisions). Transaction costs are also used in the design of employment relationships and in the design of internationalization strategies of multinational companies.
Transaction fees
Transaction fees are usually the costs incurred by a payment service provider, for example when using a credit card. Transaction fees also include brokerage fees (costs incurred by the bank when buying/selling securities) and stock exchange fees(costs of the respective stock exchanges). Transaction fees are therefore part of the transaction costs. A good asset manager also pays attention to reducing and optimizing transaction fees and can thus save considerable costs for clients (e.g. by choosing the cheapest bank or stock exchange/trading platform).