If you are reading this blog, you would probably already know: couple of weeks ago all the major stock brokers in the US allowed their customers to trade stocks and ETFs for free. (personal note: I started this blog one month after my first daughter was born, I try to write regularly, and in this case close to the news, but sometimes is not possible)
This race to zero started some years ago with the start-up RobinHood, the first app to offer commission free trading. If we look at the bigger picture, we can include this event in the wider context of financial costs going down: cheap ETFs replacing expensive mutual funds, zero cost ETFs replacing expensive ETFs, even Hedge Funds abandoning the standard 2-20 cost structure to lower their cost base (this was more driven by years of underperformance).
What shocked me most was that after the news some ‘experts’ commented the fact as negative for retail investors. Here the two main critics:
RETAIL INVESTORS WILL TRADE MORE AND RUIN THEIR INVESTMENTS
We should start with a distinction between traders and investors. A trader is a person who buy and sell stocks (etfs) actively, trying to make a profit in the process. For traders who want and act like traders this is a good news: trading commissions represented a huge cost and drag on their performance. It was also a big barrier to entry for novices: if each trade costs you 10€, you need at least 1000€ (5000€?) as starting capital for each position you wanted to have. If you want a little diversification, let’s say 10 stocks, you need 10.000€: good luck trying your hand at trading before your 30s. (No, paper trading is the worst way of understanding if you have the skill to be a trader). Now everyone can live the dream, have their dream crushed and move on in their 20s.
Above mentioned experts were referring to retail investors: non-financial professionals who invest their savings to fulfil future goals like sending their kids to university or retire. It is true that trading costs were representing a disincentive for RI to revisit their asset allocation every month or after every time they read about that hot stock. Having a financial plan and not sticking with it is the main reason people loses at the investing game…but trading costs are at best a very mild barrier, easily overcome by sentiments like greed and fear. Every investor is prone to make mistakes, now they are simply a (little) less expensive.
STOCK BROKERS WILL NOW CHARGE YOU IN OTHER (WORSE) WAYS
Do you have a broker that offered you the choice between paying a trading commission or selling your order flow to a high frequency trader? No? Well, it is because it does not exist.
Selling their customer orders to HFTs is the main way RobinHood makes profit. The other is by not giving any interest on cash balances of customer accounts. The only way to check if your broker does the former is to look at the revenue split in its income statement…if the broker provide that type of detail. Regarding the latter, we have to take into consideration the different environments in Europe and US: in US rates never dipped below 0. Most recently, when they were around 2%, the broker was gaining 2% – 0% on your cash balance. In Europe, rates are negative since a while, so here you are actually receiving a (more or less) 0.5% rebate per year by the fact that your broker is not charging you those negative rates.
CONCLUSIONS
Stock brokers are for-profit organisations. When free market dynamics and competition push them to lower their costs it is a good thing; there will always be costs involved (as they say, if something is free like Facebook, it means the cost is you) and nothing prevents them to apply hidden ones like flows to HFTs when they are also charging explicit ones (commissions).
Free trading will allow an investor to create his own ‘personal dividend’. Take the example of Amazon, which is making profits but pays 0 dividends. Now you can set, for example, your Amazon dividend at 10% of annual profit and sell shares in proportion to that level to have your Amazon dividend on your account, even with your own personal frequency (quarterly like in the US? annual like in Europe?). Well, probably Amazon is not the best example here because each share trades at >1000$ (do the math, you need to have a million invested in Amazon to do the above), but with shares that trade in the 10s$ is a viable strategy: no more high dividend obsession! I read this idea on Twitter, so credit is not mine.
Will free trading ever arrive in Europe? I think so but at the moment the main obstacle is the negative rate environment. Rates differential, being lending long and borrowing short, has been the main driver of banks profitability: European banks are already under a lot of pressure to maintain a minimum level of profits, I think they will fight before cutting ways to generate additional revenues. And I often joke with colleagues that I will never see positive rates in Europe in my lifetime so…
If you like this post, please leave a comment below.
What I am reading now:
Follow me on Twitter @nprotasoni