Is “Free” Stock Trading Really Free?
Press Release: On December 3rd, SC Public Radio Host interviewed Les Detterbeck. This message, that there is no ‘Free Lunch,’ is extremely important.
Click here to listen to the audio, and or please read the transcript below.
Mike Switzer: Since 1975, when the U.S. Securities and Exchange Commission, SEC, deregulated stock broker commissions, rates have been falling. Recently several major discount firms have announced completely free stock trading, but our next guest says that you should beware of any offer of a free ‘lunch’. Les Detterbeck is a Chartered Financial Analyst in Charleston, South Carolina, and a member of the South Carolina chapter of the CFA society, we have him on the phone! Les, welcome back to the program.
Les Detterbeck: Thank you Mike it’s a pleasure to be here!
Mike Switzer: So let’s just dive right in. Do you have plenty of clients now who are taking advantage of this free lunch?
Les Detterbeck: Many of our clients use Schwab, in fact we use Schwab as our main custodian. The equity trades are now at zero, but Schwab and others have been offering Mutual Fund trades at zero for some time. To make the major announcement about stocks and exchange funds going to zero was a pretty major one in the industry, and we have been using that yes.
Mike Switzer: Are you expecting this to spread industry wide?
Les Detterbeck: Yes, we expect that it will. That’s what has been happening over the last decades as the cost of commissions went down from $50 to $20 dollars, then $10 dollars to $4.95, so it’s not a surprise that this area of income for the brokers for much of their business that the commissions are going to be down to zero.
Mike Switzer: Does this mean then that they are making money in other ways once they have you as a client, or are there hidden fees somewhere that you are paying and don’t realize?
Les Detterbeck: No, I don’t know that there are hidden fees but there are three basic sources of income from the brokerage firms. In the beginning 30, 40, even 50 years ago, the trade commissions were the majority of their income; now it’s a very small amount. The other area has been operating expense ratios that is on Mutual Funds that they trade. There are expenses included in there and there is a portion of that fee that brokers can obtain. The last major item would be in the area of uninvested cash, the cash that’s within brokerage accounts that is not invested in specific securities.
Mike Switzer: And so they are basically able to make enough then to drop trading costs for the consumer to zero?
Les Detterbeck: Yes, that’s exactly right. None of us can begrudge them the opportunity to make a profit. They’re doing a good job, we expect they need to make income, they’re just getting it from other sources these days.
Mike Switzer: So, is this going to stay in the discount broker arena, or spread to the full service brokerage firms?
Les Detterbeck: It’s spreading although it’s going slowly that way, Mike. Obviously the big name full service brokerages have people and have brands that people love causing them to stay with them. So, we have seen some of that but it may still be a while before that changes.
Mike Switzer: Now are the firms that are offering this putting any conditions in place, like you have to have this level of account investment $100,000? 1 Million?
Les Detterbeck: We are not aware that they have that. In fact the general idea, one of the main areas as I’ve mentioned, is the uninvested cash and Schwab, that we know so well, one of their business strategies to collect more deposits, for example. A portion of those deposits will likely be in cash and they can use and invest that cash to make money there, so I think it will be something they will look at obtaining deposits in whatever size those might be.
Mike Switzer: And so Les, it sounds like that managing the cash portion of one’s portfolio might be becoming more important?
Les Detterbeck: Most definitely! Certain people may have cash; 5, 6, 7, or 10% of their portfolios, and that money is not working for them. So if the balance of their portfolio is earning 10% a year for example, but 10% of the portfolio is sitting in cash, their return is 9% under those circumstances. The result should be that investors should look at maintaining a small amount of cash, 1-2%, stay invested, stay with an appropriate asset allocation, and make sure your money is working for you.
Mike Switzer: Well Les, as always, thank you so much for your time.
Les Detterbeck: Thank you so much, Mike.