By Peter Mastrantuono
The recent introduction of zero commission trades by leading discount brokerage firms is the capstone in an evolution of declining commissions that began nearly five decades ago with the abolition of fixed commissions.
As with any product or service whose price has fallen, economists will tell us to expect higher consumption rates, and that’s precisely what has happened since the advent of zero commissions.
According to a report earlier this year by Bloomberg, a financial data and media company, trading volume at online brokerages has exploded since October 2019.
Accelerating the increased trading by individual investors has been the growth of fin-tech companies like Robinhood, which not only offers zero commission trading, but allows individuals to buy fractional shares of large, well-known companies, which has proved to be a big attraction to a new generation of young investors.
Has Zero Commissions Benefitted or Harmed Investors?
This is a question that is likely to be the subject of extensive research in the next several years. While it may be too early to make any definitive conclusions about the impact of zero commissions, the benefits and drawbacks of no-cost trading are already emerging.
The most obvious benefit of zero commissions is that it has reduced the cost of trading in stocks, ETFs and, in some cases, options. This reduction in transactional costs benefits investors by allowing them to retain more of the profits they earn through trading.
Where higher commissions may have been a barrier to investing, zero commissions have opened up a wider world of investment opportunities for individual investors. When investors have more choices, they benefit from being able to create portfolios that can more effectively help them reach their financial goals.
There are drawbacks, however, to zero commissions. The first may be that, absent the transactional friction, investors may be more likely to trade more frequently. Frequent, short-term trading can be harmful to investor wealth; there is a rich body of research and experience to suggest that few investors, if any, can successfully trade over a long-term period. One study, “Trading Is Hazardous to Your Wealth,” discovered that investors with the highest trading activity over a five-year period lagged the market by six percentage points annually.
This change in investor behavior to more frequent trading and shorter holding periods may turn out to harm one of America’s greatest strengths—its capital markets. If zero commissions result in a large and permanent class of short-term traders, it will be to the disadvantage of companies (and long-term investors) if markets fail in one of its primary functions, i.e., true price discovery. Warren Buffet has famously said that ‘in the short-term, markets are voting machines and in the long-term they are weighing machines.’ If the markets lose their ability to accurately value companies, it will be to the detriment of businesses and serious, long-term investors.
Finally, it should be said that ease of trading, thanks to zero commissions and technology, doesn’t make sound investing easier. Finding good investments is still hard work, which is why working with a financial advisor may be an individual’s best investment decision.
Peter Mastrantuono is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.
