To make the most of the brokerage industry’s recent change that moved many commissions down to nothing, investors mostly want to act as if nothing has happened.
But something has swept through the brokerage industry in recent weeks, as Charles Schwab announced on Oct. 1 that it would be ending commissions for trades on stocks and ETFs, erasing $4.95 flat fees completely, and cutting the base commission on options trades to zero too, while leaving in place a charge of 65 cents per contract.
TD Ameritrade followed suit the same day, ending its $6.95 commissions for stock and ETF trades, and taking an identical-to-Schwab pricing position on options trades.
The following day, it was E*Trade, zeroing its commission structure (from $6.95), and equaling the others on options.
And in late September – though mostly unnoticed by the media – Interactive Brokers introduced a service called IBKR Lite that allows unlimited free trades on stocks and ETFs and that pays reasonably attractive interest rates on cash balances.
All told, it is the first wave of price cuts in about two years, although plenty of industry players had already instituted their versions of free trading, or had specials where investors could get 100 free trades and then – through account activity – earn even more. Likewise, at firms like Fidelity and Vanguard, there were entire rosters of exchange-traded funds that were commission-free, even if the brokerage normally maintained a small cost for making transactions.
And trading app Robinhood has always offered free trades for stocks and ETFs, and recently added free trades on options without even a per-contract commission.
For years, commission-free trading throughout the industry has been an inevitability; as such, the price cuts aren’t particularly surprising, even if the out-of-the-blue timing is.
Of course, “free” isn’t always what consumers think it is.
While commissions have been a decreasing part of the brokerage firms’ income statements for years – trading revenue was just 8 percent of Schwab’s revenues in 2018, a bit more than half of where it was five years ago – no one should expect that financial-services firms are just going to let that revenue go without trying to recapture some or all of it.
Depending on the firm — TD Ameritrade was making nearly one-third of its revenues from trading costs – it will be interesting to see how the recovery steps taken.
It could be lower rates on cash, not that the brokerage firms are paying handsomely for it now. Brokerages keep the difference between what their clients’ cash earns and what they pay to clients. In Schwab’s case, more than 55 percent of revenues come from interest. One clear way to make up for lost commission revenue is to scale back interest payments on cash accounts even further.
Investors should watch the payout on cash balances and should move money out of cash accounts – check out the brokerage’s savings account, money-market account or certificate of deposit as easy potential parking places for those dollars – to avoid paying a rate-decline price for getting free trades.
Firms also could sell their order flow, a practice that allows brokers to let traders see what trades are being placed, allowing the traders to pay a small fee that lets them step in front of the trades to get a better price. It’s a standard, yet controversial practice at many firms; expect it to be more common.
And don’t be surprised if there are mergers and consolidation in the business; zero commissions put pressure on the operators to gather assets, which they may do via acquisitions.
When it comes to investors, there is a difference between how this saves money and how much you will save.
The zero-commissions movement means that small investors can make small, regular purchases and not get pinched. Someone who wants to add $100 each week to an investment account might have been looking at a 5 percent haircut just to make the trade each week; giving up $250 in trading costs most likely discouraged those investors into fee-free options, or convinced them to wait longer and make bigger, more cost-effective trades.
Now they have more choices for dollar-cost averaging and making small, regular moves into the securities of their choice. It’s also easier for parents to invest small amounts in a cost-effective fashion for their children, allowing them to build a small “learner’s portfolio” alongside the parents’ own accounts that becomes a teaching tool about investing.
Moreover, small traders just got a small advantage in making their moves, because the eliminated commission reduces portfolio friction, thereby widening a trader’s margin for error.
The difference is small — up to $14 per round-trip trade under the old cost structures — but real. If you invested $500 at a firm with a $5 trading fee, you knew that it would cost $10 to buy in and sell out. Thus, if your stock made a quick 2 percent gain, you basically broke even on the deal once costs were added in. Now, if you sell out with a 2 percent gain, you pocket the profit.
Here’s where investors have to avoid using their discount brain, the one that buys things on sale at the supermarket or shopping mall because it can’t resist a good deal.
Investing itself is not really changed just because trading costs have gone to zero. If an investor is lured to trade more by the reduction of costs, they’re likely to lose any savings when their market-timing efforts prove just as futile as the average person who thinks they’ll gain an edge by making more moves.
Stay the course, look at making more-regular investments and keeping the small trading fees that might have discouraged you before, but don’t be fooled into thinking that every trade made at no cost is a good one.
Zero commissions are a win for consumers, but a small victory. Pocket the savings and watch the extra dollars add up over the years, but remember that trading isn’t really free — no matter the commission structure — if you’re making bad moves.