Tuesday, October 1 Charles Schwab rocked Wall Street by announcing that it’s cutting stock trading commissions to zero. TD Ameritrade fired back immediately by lowering its stock trading commissions to zero, too. Anytime a cut in investment cost is a boon for the average investors, as a general rule. So, should we cheer for the news that these brokerage houses are cutting investors’ trading costs? Not so fast.
First, look a little closer you will see that the new zero commissions apply only to trades done online or on mobile devices, and they do not apply to transactions in foreign stocks, large block transactions requiring special handling, restricted stock transactions, transaction-fee mutual funds, futures, or fixed income investments. Also trades placed by phone will continue to cost $5 each and through a broker at $25. So, the cut in commissions literally benefits only those investors who often do online trades of domestic stocks.
Second, this move could encourage some investors who don’t trade often in the past because of the concern of incurring large amount of trading costs to trade more. Numerous studies in the past have shown that frequent tradings by timing the markets are detrimental to average investors’ long-term investment success. Whether or not Charles Schwab or TD Ameritrade’s customers will trade more often after this move remains to be seen in the future.
Third, according to Charles Schwab’s Chief Financial Officer Peter Crawford the zero-commission policy will reduce company’s quarterly revenue by $90 million. Charles Schwab, or any other company, is not a charity. Companies need revenue to survive and compete in their respective industries. If Charles Schwab cuts its stock trading commissions to zero, how does it make up for the lost revenue? For that I suggest readers look no further than the recent example of Fidelity Investments. Last year, Fidelity touted its zero expense fees funds and marketed them to the general public. Not long after that news broke that Fidelity charges customers with hidden fees and has been probed by the government. Will Charles Schwab make up for the lost revenue by starting charging hidden fees and cut corners of their services? I will leave that to readers to draw their own conclusions.
All in all, what I see from Charles Schwab’s move is a lose-lose scenario. Brokerage houses lose revenue, yet investors gain little because this may encourage frequent trading which is bad for investors’ long-term investment results.