If you have an account with one of the most popular U.S. brokerage firms, you might have noticed the news last month about a sudden change to the cost of trading commissions. Charles Schwab, TD Ameritrade, E*TRADE Financial, and most recently Fidelity all announced that investors will no longer have to pay commissions for online stock trades.
If you are familiar with the retail investing space, this move probably won’t come as a huge surprise. Ever since the rise of Robinhood, a startup company that was one of the first brokerages to offer retail investors commission-free trading, it was only a matter of time before the major brokerage firms followed suit. On October 1st, when Charles Schwab announced commission-free trading on stocks, ETFs, and options trading, the first of the major dominoes had fallen. Schwab’s major competitors like TD Ameritrade and Fidelity essentially had no other choice but to follow suit and offer commission-free trading to their customers as well.
Does Lower Trading Cost Increase Risk Tolerance
Many experienced investors that have been trading over the years will remember a time when commissions were a major expense that had to be accounted for. Each commission took away from trade profits and was simply thought of as a cost of doing business for professional traders. That’s why this recent news is such an intriguing development.
You might be both intrigued and excited about commission-free trading, but it’s important to think through what this new update really means for retail investors.
Sure, the fact that retail investors can now buy and sell equities for free is certainly exciting. The barriers to investing in the stock market have never been lower. People with low account balances that are just getting started will feel much better about buying stocks thanks to commission-free trading. Active traders are also very thrilled to learn that commissions won’t be tapping into their profits anymore. The truth is that active traders have never had a better opportunity for profitable trading. Commissions have been steadily decreasing for years. Up until this recent news, most brokerage firms charged right around $4.95 per equity trade.
What does commission-free trading really mean for retail investors? It means that beginner investors will be able to start trading with limited capital. It also means that diversification has never been easier, regardless of your account size. The money that you would normally have spent on commissions can be reinvested or used for additional stock purchases.
On the other hand, commission-free trading means that the risk overtrading has never been bigger. The temptation to buy and sell stocks more frequently has never been greater thanks to these recent changes. This is a real risk for traders that are inexperienced or trying to implement shorter-term trading strategies. It’s important to understand that just because you can trade for free, doesn’t mean you should. Overtrading is a real risk for retail investors, try to be conscious of this when moving forward.
Is it time to change brokers?
Commission-free trading also means that more investors will start shopping for a new broker. This is particularly true for existing Robinhood customers that now have access to commission-free trading with the big boys. One of the main gripes about Robinhood is that it lacks the execution, educational tools, and resources that help investors make better investment decisions and profits. The good news is that now anyone can enjoy commission-free trading along with the robust research tools on offer from the major brokerage firms.
Historically, two of the biggest factors that negatively impact trading success have been slippage and commissions, so naturally, it makes sense that the free trading movement can be seen as a big win for investors all over the country. Don’t forget to consider the reasons why this change has occurred and what it means for the future of brokerage firms.
The fact is that all of the major brokerages faced a moment of truth before making this decision. Either offer commission-free trading to customers or risk losing existing clients to other firms that do. Major brokerage firms have always received a fair amount of revenue from commissions, but the main backbone of these business’s revenue streams is margin loans, bank deposit account fees, and investment advisory fees. These brokerages will now miss out on commission revenue, so it will be interesting to see how they compensate for it going forward.
There’s never been a better time to be a retail investor thanks to commission-free trading. Just remember that overtrading is a real possibility.