Recently, many different stock brokerage firms have become no fee brokers compared to previously charging anywhere between $5 – $7 on average per transaction.
Andrew and Dave recently talked about this in an episode of the Investing for Beginners Podcast and they really outlined a potential way that this could impact the average investor. This change to many brokerage firms has been the talk of the investing world because this is how a lot of brokerage firms make their money.
No fees means great things for investors, right? The average investor is going to save $10 – $14 for each stock since you’re going to pay $5 – $7 when you buy the stock and then another $5 – $7 when you sell that same stock.
If you’re following Andrew’s eLetter where he puts $150 into a stock in each month then you were going to lose 3-5% right off the bat simply based off the commission fees that you were being charged, but now that they’re free, you’re not experiencing that extra disadvantage that you now need to hurdle! That sounds like good news to me!
But, I do think that there are some major disadvantages that could arise for investors that we need to be weary of:
1 – No commission fees make it easier to stomach selling out of your position.
This sounds like a good thing, right Well, it can be, but I think it will be bad more often than not. We constantly talk about the importance of value-investing and being focused on a long-term investing strategy and being able to easily sell out of a position might discourage this mindset.
When I was fist investing and using Robinhood (which was the first to pioneer the $0 commission trading) I was much less likely to be able to stomach the hard-times and when a stock was having a down day I might’ve been very likely to sell out of it much quicker than I should. I mean, I would literally sell out simply because earnings were bad, and the stock was taking a short-term tumble.
This was no way that a long-term investor should behave. Compare this to my Roth IRA where I literally only bought and held stocks for the long-term.
Part of my reasoning for doing this was because I was treating my Roth as buying stocks that I don’t think I’d need to sell until I retired but another very large part of this was because I was paying $5 commission for every transaction on my Roth IRA with Fidelity.
If I was putting in $100/month, I instantly was down 5% since my fee was $5 and then when I sold my stock I knew I was going to lose another 5%. It made it easier for me to just hold onto the stock that I initially purchased rather than continuously buying and selling in and out of positions.
$0 commissions can unintentionally encourage bad habits and it’s something that you need to be aware of. Stick to your guns and follow the fundamentals that you used when you wee investing in the stock in the first place.
Do not continuously buy in and out of the stock because you are not an expert trader.
I guarantee it will make your returns worse than if you just held onto the stock the whole time. Don’t try to time the market and get tricky with it because it will not work!
2 – Brokerage firms are going to find other ways to make up for this loss of revenue
These brokerage firms aren’t just going to go, “Well, Robinhood is making us lose all of our commissions now – that sucks.” They’re going to find another way to make up for that lost revenue. For perspective, Ally made over $21 million in 2017 off trading commissions alone.
They’re not just going to rollover and take that without fighting back a bit. So, were does it impact the consumer? In my eyes, it will really impact the consumer in two main ways:
Historically, the bid/ask spreads to have been very close to one another when looking to buy or sell a stock. A bid/ask spread is essentially the difference between what a stockholder is willing to sell the stock for and the price that a potential buyer is willing to buy the price for.
For instance, if I am looking to sell my stock for $200 and the potential buyer is looking to buy for $199.50, then the bid/ask spread is $.50. In other words, there is a $.50 disconnect between us.
Typically, these have been very close, and the investor won’t see much of a negative impact but now that the commissions are going away for many companies, I expect these spreads to increase. Essentially the “bid” price is the highest price that a customer is willing to pay for that share while the “ask” price is the lowest price that an investor is willing to sell for the share.
So how does a company really make money? Well, essentially in the case that I outlined above, when a “market order” is placed, the brokerage firm is going to buy a stock for something that is below that “ask” of $200, let’s say $199.60, and then sell the share for something that is above the “bid” price of $199.50, let’s say $199.90, which then nets the brokerage $.30/share.
As I mentioned, these spreads used to be very close to one another, but I expect them to expand as this is going to become more important to the way that the brokerage firms make their money.
A way to avoid this, and Andrew and Dave talk about this a lot on another podcast episode, is to set your bid/ask price and stick to it. There always is a chance that you might set your bid price at $199.50 when the stock is currently $200, and the stock might never drop below $200 again so you just missed out on your chance to buy it.
Andrew proposed the idea of setting your price when you’re ready to buy the stock and if the stock doesn’t hit it within the day or even a few hours, just bit the bullet and buy the stock where it’s currently priced at. I think this is a great plan to be honest! The key is to make sure you can stick to your instincts.
Realistically, there really is a 50/50 chance that the stock will go up or down on any given day so it’s truly a gamble if you do this. If you don’t think you can stomach it then don’t try – just place the market order when you’re ready to buy that position!
Currently, expense ratios are typically very low for ETFs, usually somewhere between .05% and .4%, depending on the goal of the ETF and the amount of time needed to manage them. I expect these to increase slightly as the no fee trades become more prevalent among investors.
People were likely more willing to invest in ETFs since some firms, like Fidelity, offered $0 commissions on some of their own proprietary ETFs, but now that all stocks are $0 commissions I expect people to be more willing to pull their money out of those ETFs.
Long story short, I think this is a way that the brokerage firms can increase some of their fees without people noticing too much…so keep an eye out!
So, what brokerage firms are actually offering these no fee opportunities? Look below:
- Interactive Brokers
- TD Ameritrade
- Vanguard Brokerage
- And others!
Long story short, no fee brokers is a great thing as long as you’re aware of the other potential pitfalls that might arise. If you continue to stick to your investing fundamentals and focus on the long-term of a stock, then you will be just fine!