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Zero Commissions, Does Not Mean “Free”

 

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Recently several brokerage firms, including our primary custodian TD Ameritrade, have announced they are moving to zero commissions on online trades involving equities, exchange-traded funds (ETF’s) and options. This move is a result of pressure from investment firms like Robinhood who have made this move in recent years.

At first glance, this seems like a win for the investor and it is to a degree. This will eliminate a nuisance fee of, around, $10 to place orders to buy and sell these securities. Let’s be real though, in some instances these little fees added up to a hundred million or more of revenue for some of these firms. Do we really believe that they are simply going to let go of this revenue without trying to recapture it somewhere else? I surely do not!

The brokerage firms are going to be hard-pressed to replace the lost revenue in other places. I believe this may lead them to recover the revenue through less transparent methods. When you were paying $6.99 a trade (or whatever your brokerage was charging) you knew the inherent cost of the trade or at least thought you did. In many instances, although you were paying $6.99 per trade the brokerage firms were deriving additional revenue from these trades in other places. The $6.99 was clear and transparent, while the other costs were not.

Zero commissions, I believe, will not mean zero cost to the client. Just as $6.99 did not necessarily mean that was the total cost. There are several ways these firms will be able to ascertain revenue, such as widening the bid/ask on securities, selling their order flow and requiring certain cash balances in client accounts.

The first two methods cited above, widening the bid/ask and selling order flow, are techniques used by the brokerages to add revenue through trading. These are methods used by the brokerage firms and custodians in order to increase their revenues generated based upon the sheer volume of orders that they are placing on an ongoing basis. The client is typically getting a fair price but it enables the firms to generate more revenue at the same time. In a perfect world, the client would pay nothing for the trade and potentially receive a better price for the transaction. As we know, nothing in life is free.

We also may see the brokerage firms start requiring clients to maintain a certain amount in cash balances to receive “free” trading. Cash balances have a tendency to be a huge source of revenue for firms. These balances are currently receiving a paltry amount of interest and the brokerages are able to lend out funds, based upon these balances, at much higher rates. The revenue generated to them is the difference between what they are paying the client and what they are receiving in interest. In many cases, this could be several percentage points of interest. Should firms require a certain amount of cash balances be maintained in an account for “free” trading, is it really free then? In my view you are simply underwriting your own trading by maintaining the balances they require with the revenue being generated.

The takeaway here should be, “free” is not free, there is typically a cost somewhere. It is important that you work with a fiduciary advisor that will review, share and discuss these potential issues with you and disclose those conflicts of interest too. Be sure to contact us, Mitlin Financial, at (844) 4-MITLIN x12 to schedule a time if you would like to discuss “free” trading further and how it might affect you and your portfolio.

Be sure to share this article with friends, family and business acquaintances who might be interested too. We look forward to helping you, and them, get on the right path and stay there.

 

This article represents the opinion of Mitlin Financial Inc. It should not be construed as providing investment, legal and/or tax advice.

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