Earlier today, I received an email from TD Ameritrade announcing their commission-free online stock, ETFs and option trades for US-exchange listed securities.
When I see the word free, the skeptical side of me started to kick in and I began questioning whether there might be any hidden terms and conditions – after all, nothing is really free in this world.
TD isn’t alone when it comes to commission-free trading. In fact, commission-free trading on US securities has started years ago with Robinhood – the pioneer of commission-free trading. Since then, more online brokerages such as Charles Schwab, Fidelity and E*Trade have started offering free trades.
When we see free, we react differently
Our brains tend to be wired to react differently when things are free. For example, we wouldn’t be able to judge the real value of the product or service when offered something for free.
For example, we would prefer spending more to meet the minimum order value when buying from an e-commerce platform to qualify for free shipping, rather than pay an explicit shipping cost.
We also tend to wait in long queues for free stuff, even if it ends up costing us more time than it should have been.
Often, when things are given for free, our brains are left to do its own diligence to assign a price tag to it, something which we aren’t so good at.
Commission-free platforms earn money in other ways
Getting you to trade for free doesn’t come from the sky, they have to earn your money in some other ways.
Some examples include:
- Incentivise you to deposit cash so they can earn interest on your idle deposits which are not routed to the cash management network
- Incentivise you to trade more on exotic products like derivatives
- Charge you for upgrades, market data and other premium features
- Charge you interest for borrowing on margin
If you look at how Robinhood makes money, which they proudly feature on their website, they stated the following:
- Robinhood Gold ($5 a month) a suite of powerful investing tools, such as Morningstar research reports, NASDAQ Level II Market Data, bigger instant deposits, and margin investing
- Rebates from market makers and trading venues
- Income generated from cash
- Stock loan income from counterparties
- Interchange fees from purchases made with the Cash Management debit card, and fees from program banks
With free trades, trading frequently can also lead to worse returns than just buying and holding forever.
In the linked research article, of 66,465 households with accounts at a large discount broker during 1991 to 1996, those that trade most earn an annual return of 11.4%, compared to the market, which returned 17.9%.
Nothing is truly, truly free in this world, maybe except the sunshine ☀ and the rain 🌧.