The big industry news in the past week is that some of the biggest brokerage firms slashed their commission rates to zero. The trend was inevitable, as declining commissions have been happening across the industry for decades. Some smaller outfits experimented with $0 trades recently, but it wasn’t until Charles Schwab, TD Ameritrade, and E*Trade announced it this week that the inevitable “race to zero” is really here.
But what does this mean for investors? Advisors? Brokerage companies? Here’s my take.
Investors. For investors, my initial thought is this is MIXED news. Instead of paying the $5 to buy or sell a stock/ETF, investors can now pocket those trading costs. Depending on how much they trade, the commission savings can add up. At the very least, portfolio rebalancing and dollar-cost averaging just went from costing “almost nothing” to “nothing”. So there’s that.
On the flip side, could free trades actually encourage bad behavior (i.e. more trading)? I think it would. This could potentially hurt a do-it-yourself investor, as it could lead to more ill-advised or shorter-term decisions just because the cost of making the moves is “free”. People should be wise and not blow up their financial gameplan because trading fees are eliminated.
Advisors. I can’t speak for all advisors, but TrustTree Financial has always paid for client’s trading costs and never passed them along to clients. In other words, if a transaction occurred in a client account they would not pay any additional cost. With most of that going away (*note I still have some costs affiliated with trading mutual funds, options, and some other products that I use) it will obviously save me a few dollars. And by “a few dollars”, I really mean that. Our trading costs are less than 1% of our total expenses, so it’s really trivial.
I also know the zero-commission finish line will not affect my trading habits one bit. I hadn’t refrained from making client trades in the past because there was a cost, just like I won’t be doing more trades now because they are free. In the unlikely event a client suspected I wasn’t trading more because it cost money, there is nothing stopping that now! So, for the moment, these changes are POSITIVE for advisors like me. Unless of course, the firms start charging the advisors to be on their platform (which wouldn’t come as a surprise).
Brokerage companies (aka Custodians). All the custodians mentioned above will lose millions of dollars of trading revenue, but the effect will vary. Schwab, for example, gets less than 4% of its total net revenue from trading and may not be impacted too bad. Some call it a loss-leader for them. But for companies like TD Ameritrade, it’s substantially more at 16% of their total.
One would conclude then, that the firms will have to make up for the lost revenue in other ways. And I am sure this will occur on some level(s). Firms can continue to make a big spread on money market balances (ever wonder why your cash balances weren’t paying much?). Firms might go through cost-cutting measures like staff reduction, which could impact service levels and things like customer service hold times. Firms also make money on order flow and the number of trades that it processes, so the “free-trade” announcement could lead to greater market share and more flow.
Lost in the headlines is the decision of behemoth Fidelity Investments NOT cutting their commission charges to zero. Although they may do it in the future, they are currently citing several reasons for their decision to stand pat. Fidelity maintains the value of their offering, their higher-than-average money market rates, and their technology offering to be more of the drivers to keep clients and advisors happy. Plus they don’t want to run the risk of having to cut staff or reduce their service quality. So there’s that.
In conclusion, the “race to zero” makes for great headlines. But most of this is will be business as usual and won’t affect the average person drastically. And for those individuals out there thinking they are going to make more money now by doing more day-trading, I would encourage them to think again. It usually doesn’t work like that. Buy and hold is still the best approach, no need to overreact.