On October 1, 2019, Charles Schwab (the company, not the person) announced that it was reducing commissions for online trades of U.S. stocks, Exchange-traded Funds (ETFs), and options. This bit of news may not have meant much to you if you don’t have any equity investments outside of a 401k or 403b. But, for a partial do-it-yourself investor like me, it was nice piece of good news. TD Ameritrade and E*Trade followed suit shortly after Schwab’s announcement,with Fidelity following suit a week later, making this even better news, giving small investors more lower-price options.
If you’re keeping score, you can now get free online trades from Robinhood, Schwab, TD Ameritrade, Fidelity, Interactive Brokers, and E*Trade.
Paying Commissions: A Personal History
When I first started investing in the mid-90s, the internet wasn’t as robust as it is today, and the cheapest trade I could find was around $20 at a company called Dean Witter, which was eventually swallowed up by Moragan Stanley. As I took my debt-induced break from personal investing, the internet got more useful and investments could be had for a little less than $10 per trade.
By the time I had fixed up my debt situation enough to start investing on my own again in 2017, most online trade commissions were in the $4.95-6.95 range. (Robinhood was available starting in 2013 with no commissions, according to this article. But, I wanted access to the workshops that Schwab provides at its physical locations.)
How $0 Commissions Changes Things
You may be wondering how much difference $4.95 can make. As far as your 401k/403b goes, not much. And, if you have a do-it-yourself account where you just took advantage of investments that were already commission-free, also not much. But, if you like to own individual stocks, it can mean a lot.
Let’s say you’ve got $500 to invest.
Let’s look at how a $4.95 commission impacts that $500 investment vs a $0 commission. (Note: There’s nothing magical about the 8% return I’m using below. It’s just what I picked for my example.)
As you can see, over time, that $4.95 commission starts to add up over time. After 40 years, that commission cost our imaginary investor over $100. Not a huge amount in the grand scheme of things, but you get the idea. (And, imagine repeating the process several times.)
Not to mention, imagine if our new investor only had $20 or $50 to invest. The $4.95 commission can make that a non-starter. I’d keep my money in savings or maybe grab a nice meal, instead.
Why It’s Not Just About the Math
There are other factors other than math involved in why a $0 commission should be celebrated. A $0 commission lowers an important psychological barrier for smaller investors.
While you may point out that there were a lot of investments available to anyone that had no commission charges associated with them even before Schwab’s announcement, I believe most people would look at a website, see a commission, and assume that whatever THEY wanted to invest in would get them an extra $4.95-6.95 charge tacked on to whatever they could invest. Seeing a $0.00 there instead makes a person more likely to investigate one step further.
If that person continues on to open an account and start investing? Well, that can start a good habit in that person’s life. They might make some mistakes by over-trading at first (I did) and they might need a little guidance somewhere along the way. But, they have started along a good path. And, once people have started on a path, they tend to stay on it.
A Few Caveats Before I Go
Some columnists have (correctly) that the lowering of trading commissions to $0 doesn’t come without costs. I still think the smaller investor comes out ahead, overall, which makes the costs worth it from my point of view.
Here are some of those costs:
- $0 commissions will lead to over-trading in accounts.
- Yes. Not having to worry about a commission makes it easier to buy and sell in and out of investments more often. This over-trading has traditionally meant lower investment returns for the majority. I’m choosing to focus on the fact that it is also easier to just buy into investments and hold them for the long term.
- The money you keep in cash will now earn even less interest.
- You weren’t earning that much interest in the first place.
- With no commissions to worry about, I’m more likely to buy a smaller number of shares at once. That means I’m in cash for a shorter period of time.
- If the cash is in one of the firm’s funds, you have no control over the amount of cash in said funds. You could keep track of this and move to other funds. Most people don’t or won’t do this. So, there is a valid point here.
- These brokerages will be more aggressive in their pursuit of making money from order flow.
- Enter your purchases and sales using limit orders (where you state the price your willing to pay for or sell each share). So, I’m not that concerned with the behind-the-scenes action if I get my investments at a price I’m willing to pay or sell at.
- I will admit to a limited understanding of “order flow”, though.
So, while there a few reasons that “free” trades are not really free, I think the benefits outweigh those issues.
Thank you for visiting Finunciate. Come back soon.