Charles Schwab and TD Ameritrade have both announced that they are eliminating their usual commission for stock, option and ETF trades, to provide free trades to their customers. In the coming days, we may see other discount brokerages follow their lead, in part, or in whole.
Until now, most brokerages only offered free trades on select securities, often on company owned mutual funds. For example, Fidelity has a list of mutual funds customers can buy for “free.” Schwab has a similar list. This new move opens up free trades to the world of stocks and options.
Trading vs Investing
New investors often confuse the concepts of trading and investing. Trading seems exciting and romantic. While it very much can be for the right people, the average person actually needs to be investing for long-term goals, rather than slinging stock trades.
For investors building a well-diversified, long-term portfolio high commissions can impose an overhead that diminishes returns. That’s why low-cost brokerages like Schwab and Fidelity are preferred for many do it yourself investors. Zero-cost takes it one step further, providing the opportunity to build, maintain, and re-balance a portfolio without the added overhead of even a low commission.
Traders, obviously, will welcome free trades. There were many ways to get “free” trades previously, including having a certain size balance, or paying a flat percentage annual fee with other advisors or investors. The nice thing about these brokerages offering free trades in their main brokerage accounts is that there is no need to jump through hoops to get those free trades elsewhere.
Long-Term Investing With Free Trades
Individual stocks can be an important part of a diversified portfolio. In these cases frequent trades are both unnecessary, and likely detrimental to the investor’s long-term goals. As such, paying $4.95 (Schwab’s old commission) to buy 100 shares of Apple stock ends up being an insignificant cost unless you are buying and selling frequently.
However, there are two scenarios in which zero cost trades will be a nice perk for investors. First, for investors who like to add to existing positions as they invest new money, this avoids the issue of having to wait, or build up a certain investment amount. In the above example, an investor with 100 shares of Apple stock might want to add $500 to their position. Doing so with a $4.95 commission actually works out to a 10% hit up front. With zero cost commissions adding smaller amounts to existing stock positions makes sense.
The other scenario where free commissions is a nice boon is for those who like to rebalance their portfolios more frequently. Rebalancing once per year is enough for many long-term investors, especially when it comes to retirement investments like IRA accounts, or 401k rollovers. However, for investors working on different goals, or those with shorter horizons, more frequent rebalancing might be desirable.
Often rebalancing requires several smaller transactions. Rebalancing a diversified portfolio with a few dozen stocks might take 20 or more sells, followed by 20 or more buys. That “small” $4.95 commission start to add up pretty quickly when you multiple by 40.
Free Trades Not Free Funds
It is important to note that the free trades are for stocks, ETFs, and options only. This does not affect any mutual funds that have loads, or other investment costs. Many investors stick to mutual funds or other managed investments, and these changes will have no effect for them.
However, savvy investors already choose lower cost, preferably no-load mutual funds to construct their portfolios.
In the end, less expenses is always better for investing and banking, so this is a move in the right direction for many do it yourself investors.