IFB124: The Fallout from No-fee Commissions on Wall Street

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Dave:                                    00:36                     All right folks, welcome to the Investing for Beginners podcast. This is episode 124 tonight, Andrew, and I thought we would take a break from Listener questions and maybe some of the other formats that we’ve talked about lately and talk a little bit about some current news. So for those of you out there living in a black hole of news, there was some big, big news in the stock market recently this week and there was some news that a lot of the online brokers have dropped to zero fees and Andrew and I wanted to talk a little bit about that. So Andrew, did you have some thoughts? I hear I hear you take it in. Take a breath.

Andrew:                              01:19                     Somebody hold me back. Hold me back. Yeah, I think it’s like we’re watching history being made, right? And for somebody like me, I’m trying to encourage people to invest. Now. There’s no excuse. You had the emergence of Robin hood and what made Robin, what made everybody flock to Robinhood was the fact that you could trade, and there would be no commission fees. And this week just, it was like dominoes, and they just fell one after the other. So I logged into my ally account and saw this little message on the top that said, Hey, starting October nine, we are not charging commission fees anymore. Ally used to be a four 95 portray commission, and now it’s not. And then, you know, I think I think before that was what were we, what were we saying? I was like interactive brokers before that. Yup. Yup. They were one of the first ones. Goldman Sachs was I think those were one of the first two that, that went that route. And then like you said, the dominoes kind of started to fall. Schwab was the next really big one that kind of really shook up the investing world. And then soon after that followed

Dave:                                    02:33                     The TD Ameritrade and E-Trade to Fidelity. I think it just announced a day or two ago and an Ally, I didn’t see any news about Ally, but like Andrew, I, I logged into my account, I saw this little notification from them, and it’s like some weird, so yeah, it’d been, it’s, it’s a, it’s pretty exciting. So I was doing a little bit of reading fro about interactive brokers and for them, I can’t speak to their companies, but I’m going to guess it’s very similar for them. It’s us stock trades only. So if you’re buying companies in the United States it, they’re free. If you’re buying co companies outside of the United States, then it’s not free. But yeah, any, and you want to buy Johnson and Johnson, or you want to buy the newest cannabis doc, it’s all no zero commissions, which was rather nice.

Dave:                                    03:25                     Same thing with Ally. I had, you know, I had to test it, I put some money in and then just did a couple of trades here and there. So all the buys were free. That was super cool. And the honest sell there was like a 2 cent fee still that goes to the FCC. But I think I’ll take 2 cents over four 95 yeah, no kidding. No kidding. Yeah. So I remember, so for your $150 a month investment, then how much of a percent was that? Four 95 that was like 3% yeah. So that’s gone now. I mean, that’s, that’s an extra 3% you’re going to make on every single buy every single month. That’s, I mean, that’s awesome. A, you must, you probably figured out what I was going to do this anyway, but I had to put that into a compound interest calculator before.

no-fee commissions

Dave:                                    04:17                     Of course, it sounds like not that much $4 and 95 cents but compounded over for the years and the average stock market return of 10% a year, that turns into $26,514 so yeah, that little 3 % each month will really add up over time as it continues to compound on itself. Wow. That’s amazing. That’s, that’s, that’s cool. Yeah, that’s, that’s, that’s pretty exciting. So what do you think triggered this? I think it like you said, I think it was the Robin hood the threat of Robin hood. I think that’s really what kind of broke it open and caused this to start happening. What are your thoughts? I think you’ve been doing a lot of research on I think banks and the finance industry in general. Yup. Yup. From what I, my very layman’s understanding is the money isn’t necessarily made, like for Robinhood.

Dave:                                    05:21                     I, we, we’ve talked about this in the past. Like there’s no such thing as a free lunch, and they’re not just going to give you free. If you’re getting these free commissions, then there’s, there’s some other way you’re paying for it. And so it was kind of widely known that they would kind of skim off the bed in the ask. So don’t ask me about like if I understand the technical details or if I can explain that, but essentially, you know, they’re skimming off a little bit from what I saw, what you sell, what would I buy, what you buy. And then that’s kind of how they make their profits. But you know, some the, so that was like their competitive advantage. But big other companies like Schwab or Fidelity, they’re not so much from my, again, layman’s understanding, it’s not the commission trades that make up a big part of the revenue.

Dave:                                    06:12                     It’s more of the fact that it’s not a gateway, but it’s like a way to secure a customer and then not upsell them but have other kinds of services that run parallel where the company now makes a lot more profits on that SA yup. Somewhere in the ballpark. Yeah, that’s exactly in a ballpark. A, you’re, you’re very, very warm on the ballpark. Yeah, that’s exactly what it is. You know, the Wells Fargo when I worked for them, that was always one of the big mantras that we talked about a lot when I was at the bank was in essence the stickiness of the bank and having, having our customers have as many services with us as we possibly could because then there were far, far less likely to weave you because an of the difficulty and B, because you just had so many things going with them that it just, it was way more work to, to, to leave than it was to stay.

Dave:                                    07:17                     And even when the bank went through that horrible scandal with all the fraudulent activity that was going on, you still had, you still didn’t have that much churn. You didn’t have that many people weave the bank. And there was always kind of an inside joke at Wells Fargo that, you know, people had longer relationships with their banks than they did with their significant others. And, you know, and it’s true, you know, I can’t tell you how many times I would have a customer I ask Taka to be, and you know, they may have gone through a, you know, a divorce or two or you know, a string of boyfriends or girlfriends, but they’d been with the bank for 26 years, you know. And it’s just, you know, it’s just, that’s just the nature of the business. But that’s, that’s really what that’s the calling card.

Dave:                                    08:04                     Like you said, it’s getting, it’s getting people into the, the ecosystem of the bank or whatever that is, and then offering them other services and things that will make the bank a lot more money, whether it’s through investments, whether it’s through, you know, something like a CD or just having money in a savings account or IRA or any of those kinds of things. There are just so many other ways that, you know, the bank can, you know, entice you to try to stay with them. Hopefully it’s because of good service and because you’re benefiting from all those things. But you know, that’s really where a lot of that came from. So this whole news with this zero commission thing inter and I were kind of talking about this little off the air, the stock market. This is a classic example of some of the things that Andrew and I’ve about in the past.

Dave:                                    08:56                     The, the overreaction of Mr market to this news was kind of staggering. You know, I believe the day that Schwab announced that they were going to go to zero commissions, they dropped like 10% in one day. Goldman Sachs I believe, dropped like eight or 10% interactive brokers, 10 15%. TD Ameritrade dropped 25% in one day. This because of the news of people, like you said, not understanding the business model and freaking out because they think that that’s where these particular houses are making the majority of their money is from the commissions of doing trades. And that’s not the case. I was reading an article about interactive brokers because I, it peaked my interest when I found out that, you know, a company like that, which I had been looking at previously dropped that much. I, you know, my first thought as a value investor was, Hey, how you do it?

Dave:                                    09:58                     There might be an opportunity here, you know, and to be honest with you, that’s the first thing that popped in my did the, well, no, the second thing was like, sweet, I’m not going to have to pay to buy stocks, you know, Hey, that’s awesome. But the second thought was, well, Hey, what can I buy from this? Well, how could I benefit from this opportunity that could have been presented because Mr market freaked out and they started, you know, dropping the prices on all these companies? So, you know, I did a little research, and I found a couple of things that might bear looking further into to get, get into because I could buy them cheap. So yeah, any lab maybe particularly stood out as, Oh, this doc might be worth a second look. Or I was like; it’s a good thing the stop drop because this could have a big impact.

Dave:                                    10:53                     To that that were, are intriguing to me. It was Goldman Sachs, and the other one was Interactive Brokers. Both of those are companies that I guarantee you that I will be writing more about probably in the next couple of weeks as well as, you know, seeing if that’s something that I would want to invest in personally. One that I think is going to take a big hit because it’s going to take a big hit is TD Ameritrade. The other two companies have other things going on, like interactive brokers for example, just real quickly, the majority, not majority, about over half of their income comes from overseas because they do a lot of business outside of the United States and they have a lot of people trading outside of the United States. This perk doesn’t; it doesn’t take them into account. So there’s still going to be making money from, from those trades.

Dave:                                    11:48                     At least for this point in time. That may change, but I don’t, I don’t, there’s doesn’t seem to be an occasion that we’ll, so interactive brokers is not going to take as big of a hit as people think they were going to initially. Goldman Sachs they have, they’re an essence of bank and so they have other avenues for revenue outside of this commission-free, you know, hit that they could take. And realistically, just by the brief numbers I looked at, Goldman Sachs may lose possible revenue of one and a half to 2% over the next five to 10 years, which in the grand scheme of things, they could make up in other ways. So it’s not, it’s not a horrible monstrous hit. Now TD Ameritrade, however, their whole bread and butter are trading in the United States. And so that’s where a lot of their income comes from, is from the commissions.

Dave:                                    12:44                     They’re good, they make money other ways, of course, but that’s where they’re going to take a hit. So, you know, I guess to my point of all this is that just by doing a little bit of initial research, I was able to figure that out just by looking at that. And you look at the market, and they had treated them all the same. Yeah, they did. They just looked at all of them as like, you know, bad, bad, bad. I mean, it didn’t, it didn’t crater like Wells Fargo or bank of America or a US bank much or even some of the smaller banks like SunTrust or Ally or any of those banks. It didn’t crater them hardly at all because the investment portfolios are there. That portion of their business is not as big of a; it’s not as big of a, an engine for them.

Dave:                                    13:33                     You know, the, a much bigger engine for them is, you know, loans, you know, that’s where they’re generating a lot of their income from is from loaning people money to buy cars, homes, whatever it may be. So they didn’t create her. But yeah, the ones that were primarily investment houses took a much, much bigger hit. Fidelity kind of, you know, they have a bank model too, so it’s not Schwab is, is more of an investment house too. So I mean they took a bigger hit, but you know, those are things that I’m going to be looking at it. Cause as I said, you know, as a value investor when you see something like this it’s like Ooh, Hey, it might be something going on here. I’m curious what, what happens to Robin hood from this? That was their only, I mean that was, that was our calling card.

Dave:                                    14:22                     I mean, that’s the biggest thing that they had that, and I guess and personal shares. Yup. Yup. But you know, so well I get excited about it is we, we try to teach beginners as a start. One of the things that I think we used to say a lot, and maybe we should keep saying that more, is you know, just by that first doc, even if it’s just one chair get your toes in the water and feel what it feels like to own a stock. Well guess what? Now you could buy a $5

Andrew:                              14:52                     Stock at $10 stock and not have to pay four 95 for it’s free. So you can start that drip process. You can start getting that compounding, and you don’t have to pay the fees involved with that. And so kind of like what people did with Robin hood where they would take these really small positions and not feel intimidated. Now you can do that and just start small, build small little pieces of a share here, share that. And that really, there’s no downside to that. Not like it was before where if I wanted to buy a $20 stock, I should buy like at least ten shares of it. Right. Or where the transaction fee was going to take such a,

Dave:                                    15:34                     You hit our of that. So yeah, exactly. No, this is, I mean, this will be, you know, for us, quote-unquote peasants, this is going to be, you know, a big, it’s going to make a big impact on, you know, getting people started. And I think, I’ll be honest with you, I think that’s probably one of the drivers behind this because Robin hood has been talking about an IPO and going public for a little while. And I think the big houses were afraid they were afraid of that. And I think for that very reason because it would entice, you know, people, especially younger people to start investing and the more market share that Robin hood was able to take away from fidelity, then that would impact their business longterm. And so by doing something like this, this, you know, helps entice, you know, the average person on the street to, you know, Hey, if you want to, you know, what would it be like to own Apple?

Dave:                                    16:35                     Well, let’s buy a couple shares and now you can do it and not have to worry about having to pay that, you know, the four 95 or what, eight 95 or whatever it was with whatever company you’re using at the time, you know, that would be money that you could use towards that trade or you could buy a coffee after you bought your first dock, you know, or a glass of wine if you’re so inclined. So you know, there’s just so many different ways now that you can go with that and I think it will help encourage people to start investing, which is what you, I’ve been talking about for the last two-plus years.

Andrew:                              17:12                     I remember when I started, I mean unless you’re, I guess somebody who works in the finance industry, I think the word finance itself can mean a million different things. And you talked about how all these different businesses have such diff, such varying business models that dip their toes in banking or investments or whatever. And so like as somebody who came in as a beginner and wasn’t entrenched in the life kind of a thing, I, I know I saw the brokers is just the same. And so all I met like what drew me to [inaudible] ally Bose trade TradeKing before ally bought them was the fact that the commission was so low. And so I think, I think that was their big calling card. Yeah. And it became like a race to the bottom, and now you see what can happen with a race to the bottom as it can hit rock bottom. And I think that’s interesting. I didn’t know what you were saying about the IPO that they were thinking of doing that. And not to like derail the whole conversation, but it’s interesting I think to hypothesize about what that IPO could’ve done for Robin hood and if it could have helped it gain market share because I know you read the Italys thing about Tesla, right? How he is, how the companies can fund it.

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Andrew:                              18:53                     Before we sign off, I think I would like to kind of hit on that a little bit. The sheer w w we talk about Tesla all the time and how negative we are about it. And it’s because they, they hemorrhage money, they’re, they have a business model that burns cash. It’s, it’s so clear, and it doesn’t matter how you kind of slice it up, it’s, you look at the financials and if you understand that then you can see that they are not very good at making a profit and haven’t been for so long. But it’s like, well how is a business who can’t make a profit? How are they able to stay so long in business? And going back to what we talked about way back and back is back to the basics series in the forties, I think it was like 40, 41, 42, something like that.

Andrew:                              19:43                     It kind of goes back to the power of tapping the stock market and using that for capital. So I read what Natalia was talking about with how Elan has been such a master marketer and, and the way that essentially they’ve been able to fund all these losses is through a lot of the stock dilution that has happened. And so when you have like an IPO is like an easy example of it because you’re putting the company up and they’re up for sale, and then investors can come in, and then they each buy their little piece of the business and then obviously the person selling gets that capital, right? So with the business, when they are diluting shares, they’re increasing the number of shares that are out there, and they’re bringing in cash for that. And so I was like really curious after reading one of the Italian said, and I plugged into a spreadsheet and I was kind of adding up, I, it wasn’t exactly precise, but you know, around where it was the market cap at this time around w what were their shares.

Andrew:                              20:57                     And then as the year has gone on and you can see if you track over multiple years and in Tesla’s history you can see how their, their market cap has gone up obviously because they were super popular in the stock market but also at the same time they’ve had not like a huge amount of dilation but like a decent amount where it’s like okay, this is kind of significant and so they’ve really been able to paper over a lot of those losses based on the fact that their stock is so popular and I just, the fact that it’s gone on for so long, I don’t know if if history has set a precedent for that, having been able to continue for so long and what I took out of that with what Vitaly said, I’m not doing his peace justice and if we can link to it, I don’t know if he posts online.

Andrew:                              21:48                     I saw it in one of the daily emails, but it will be interesting to see, like if they can keep that high valuation and keep the momentum behind the Tesla stock going, then once they do hit profitability, that like, and made it scale where they can be profitable. And that could have been like, I don’t want to say like a heist, but just an amazing fee of literally throwing so much cash into a fire and yet being able to survive it because of the craziness of the market. And I don’t know if any other company has, has done something as extraordinary. I wouldn’t think so. I mean, thinking back on the history of [inaudible],

Dave:                                    22:36                     You know, of the stock market, I can’t think of any company off the top of my head that has been able to, you know, like you said, hemorrhage money for this long and still stay viable. It’s, it’s somewhat remarkable actually. I mean, it’s, you know, to me it’s, it’s a, it’s a Testament of the, as Vitaly called it, the cult. It’s, it’s a testament to the cult that Ilan has built around him for the believers in the company. And it, you know, Vitaly mentioned several times in his article that there was not a lot of how did, how did he put it? There weren’t a lot of middle feelings about it. You were either for the company who against the company, you know, bears and bulls and there wasn’t a lot of in-between. And I think he’s right about that and it’s a very polarizing company and the fact that it’s been able to maintain its, you know, market advantage if you will for so long is, you know, like, like he said, it’s, it really is a Testament to Elan’s cult ability

Andrew:                              23:46                     And his ability to, you know, keep, keep the company going after all these years. Because you and I try to think about that on our note. You know, how, how long would our debtors allow us to keep going without paying them back? Whether it’s for a mortgage or a loan, Carl’s food. I mean, if you try to go to the grocery store and buy food without money, they’re going to, they’re going to send you, they’re going to send you away. It’s not going to happen. So I mean, that’s in essence kind of what’s going on with the company, and it’s; still, it’s hanging in there. It’s pretty amazing. Yeah. I mean it’s, it’s a complicated situation. I don’t want it; I don’t want to make it sound like I’m saying it’s as simple as this. When in reality it’s not, but like if you take the shares and kind of look at how they’ve done it from year to year, the year like 2012 they grew shares like seven, 6.9% in 2013 and I was like 11, you go to 2016, it was 12% 2017 it’s 14%.

Andrew:                              24:51                     So, you know, not like huge dilations, but significant dilutions kind of spread out. And when they had market caps in the multi-billions, right? 18 billion, 20 billion, 30 billion, 31 billion. The math isn’t as simple as that. I’m sure when you get down to how dilution of shares and how that affects cash flows and everything, but just back in the napkin math, you start to see, wow, okay this is how it was able to be done. And so circling back to the Robin hood thing, I’m an IPO is a little bit different because the founders are cashing now and then you have public ownership. But kinda to your point, and these may be Barker’s being scared of what that could have done and if, if Robin hood could IPO, then if they could have got this momentum and then you had wall street craziness for whatever reason, become fans of the stock and then what that could potentially do to that industry.

Andrew:                              25:57                     Maybe that has a big factor towards why we have seen this cascading of really great news in my book. But I, I don’t see how you go back from this. When you race down, like how can you be the broker that says, you know, everybody’s free now. We’re losing money, and we need to charge you $2. Unless they somehow make the switching costs so inconvenient. I don’t see how that can happen. Yeah, I would, I would agree with you wholeheartedly. I think once you, once you go down that path and you go to the zero Mark, you just, how can you go back up? I can’t see it.

Dave:                                    26:44                     One of the things that I think as we’re talking about this to keep in mind when you’re thinking about possibly investing in these kinds of companies, one of the things that you’re going to want to do is look and see, you know, where are these companies making their money from? Is it coming from the commissions or if it’s coming from something else? And I’ll relay comments that I heard a lot when I worked at the bank. People would come in and be upset about order at charges or fees that they got charged on their unearth checking or savings accounts. And I understood the frustrations and me, I, you know, I F I felt for them, I did. And I knew it was frustrating and you know, we had to deal with it on a daily basis, but you would hear comments from people from time to time about, you know, can’t believe the bank is doing this and there, you know, they’re making all their money for me and that kind of thing in it.

Dave:                                    27:37                     When I first started working for Wells, I, I, I admit, I didn’t know enough about kind of how the bank made money. And so I agreed with them honestly. But then once I started working for the bank, and it started getting into the whole investing thing and talking to the different people that worked at the bank, it started investigating the financials of Wells Fargo. I came to the very quick realization that that, in fact, was not the case, that they did make some money from it, but the majority of the income was made from loans making know, making loans to people and the spreads that they would make on the money they borrow versus the money they loan out. And that’s really where the income comes from. And the majority of the banks, that’s how they make their money.

Dave:                                    28:21                     And so it was really interesting to kind of delve into that and discovered that. And those are, those are some little tidbits as you’re starting to possibly invest or look at a Goldman Sachs just because I said something about it as a B, you should go up by eight. You should do your research and, and discovered if you have questions, let me know. I’ll try my best to help you. But I, you know, I think you just need to, to understand the different business models and that’s, that’s one of the things I wanted to, I guess I wanted to kind of point out about how Mr market reacts and overreacts to the dues and just looking at the whole picture as opposed to just going, Oh my God, you know, this is, you know, the, they’re going to lose all their money. The how are they going to make any money now?

Dave:                                    29:06                     Well, they have, they have other, you know, you got to remember the people that are running these businesses by and large are very, very intelligent people. And they’re not just going to make knee jerk stupid quick reactions just because somebody else’s doing something they, they all had these contingencies already thought out and planned out. And when Schwab pulled the trigger and made the big news splash, then everybody else already had. That’s how they were able to react to these so quickly cause they’d already gone through this. They already knew that this was a very real possibility, and they had contingency plans to enact all this to make it happen quickly. So that’s all I got to say. That’s, and that’s a great point, and I think it confirms everything we try to teach and there’s a lot of power and knowing how to look at stocks the right way and how they interpret things versus having a market-focused kind of approach and feeling the ups and downs from that.

Dave:                                    30:08                     Yeah, exactly. I think one of the things that why I’m thinking about this one or the thing that I, I guess I wanted to illustrate, is when you’re thinking about the stock market, or you want to invest in you want to learn more about it and stuff. By and large it’s okay to watch the news, and it’s okay to watch, you know, Bloomberg TV or CNBC or any of these kinds of things but don’t have it on, you know, six hours or reruns. You’d drive yourself nuts, and you’ll get, you’ll get influenced unfairly by the hype and the enthusiasm that the people on TV are broadcasting to you because that’s their job is to get us excited and make us want to come back and watch them more and more and more. And it’s okay to watch half an hour of, you know, a financial news report and get a, an overview of what’s going on or you reading something from seeking out or going on Twitter and reading some of the fin twit stuff that some of those guys are talking about.

Dave:                                    31:15                     Just to get a flavor for it, but then ignore it. You know, the rest of it just it’s not, it’s not worth it and it’ll drive yourself crazy and you’ll get so excited or so bummed that you overreact and make a snap decision as opposed to trying to make an educated informed decision and you make an educated informed decision, and you feel like it’s right. Then Hey, go for it. But if you’re reacting on your emotions, then generally that’s going to be where you can burn yourself. All right folks. Well that is going to wrap up our discussion for tonight. I hope you enjoyed our conversation about zero commissions and all the ramifications and the ins and outs of that and how Mr market can play several things if you if things go the way you don’t want. So without any further ado, I’m going to go ahead and sign us off. You guys go out there and invest with a margin of safety emphasis on the safety. Have a great week, and we’ll talk to you next.

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