Investor Minute
Study Finds That “Free” Trades Could Be Costing U.S. Investors Billions
You’ve probably heard that the most powerful word a marketer can use is “free.” After all, who of us can resist getting something for nothing?
Sometimes free really does mean free, like that cheese sample at the grocery store, or the old shelf someone is giving away on Craigslist. You get the item for nothing and there really is no further obligation.
But most often, free means you’re still paying for the item. The cost is just hidden or deferred. We know that when we order something online and it comes with free shipping, the cost of UPS bringing it to our house is reflected in the price. Still, we feel better about the purchase when we can tell ourselves that some part of it was free.
This principle that there really is no free lunch is very much in effect in the financial world. Despite marketing language to the contrary, it costs money to operate in this sector, and to make a profit companies must pass their costs along to you one way or another.
The no-fee stock trading companies are no exception. Robinhood, the mobile trading app that grew rapidly during the pandemic, made speculating in stocks easy, fun, and apparently, free. But it soon came out that the company was making its money in hidden fees.
Christopher Schwarz, a finance professor at the University of California Irvine, was looking to compare the hidden costs to day traders assessed by the five major market makers (companies that actually execute the trades). He could not find available data on this—the costs being very well hidden—so he organized a group of colleagues to run a study where they made their own trades and could compare the actual costs.
Writing about this study for Advisorhub, Kim Stewart reports, “Over more than five months, the academics used their own funds to execute 85,000 trades in 128 different stocks and made what they considered an important discovery: They were getting significantly different prices to buy and sell the same stocks, depending on which brokerage handled the trade.”
In one example, the professors opened two brokerage accounts and placed identical orders. The next day, one was down by $150. The other was up by $12.
Stewart writes, “Extrapolating from the results, they estimate it costs small-time US investors as much as $34 billion a year.” As you might expect the paper published on the study concludes that, despite their name, so-called “no-fee” brokerage accounts for day-trading often come with ample hidden fees.
The prudent investor knows that fees are one of the costs of investing and to expect to receive a valuable service without paying for it is naive. However, the smart investor also knows that it’s possible to keep fees and other costs low, especially by avoiding needless transactions.
We are committed to fee transparency as we guide you along the path to long-term success. Click this link to make a free appointment today with any questions.