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The Upside of Commission Free Trading

I hate short-termism and anything that feeds on it (financial news, get rich quick schemes, etc). It is, in my opinion, one of the most destructive aspects of any financial plan as it chews up taxes and fees thereby making the average investor more active and mathematically worse performing. Commission free trading feeds on this. It is essentially an incentive to trade more, as these trades, which are quite costly, are viewed as being cost-less.

I bring this up as Schwab and Interactive Brokers join other brokers in eliminating commissions. It’s a move to try to retain or attract customers who view commissions as an important cost. Given that these firms still generate substantial revenue from trading it’s clear that the move is mostly targeted at the high churn customer. This isn’t necessarily a good thing because it could incentivize other people to engage in something they think is cost-less, but actually quite costly. But I’ll tell you an anecdote about why low commissions are great and a sign that greater times are coming.

When I was a young broker at Merrill Lynch I worked on a big team. My bosses were great and the firm was going through a big transition at the time as the industry grappled with the rise of index funds. We were slowly turning over our book of business from a commission based business to a fee based business. But I was still hitting the phones every day trying to generate commissions while I searched for fee based clients. Honestly, it was an unusual time to be starting in the business because my training was pushing the fee only approach, but my team was still largely commission based and the firm still charged very high commissions.

The worst part was that my then girlfriend (now wife) was especially savvy with money and she had a Free Trade account. She was already way ahead of the game, but she would tell me about how she invested part of her paycheck into these new iShares ETFs for $0 commission. And I would be like, “oh yeah, well Mr. Financial Advisor over here bought some XYZ Stock for a client with a $2,000 commission today!” It all made me feel extremely conflicted.

It wasn’t long before I’d built up a small book of my own business. Many of them were friends and family. And I’ll never forget the day that my view on fees did a complete 180. We got an analyst report in the morning for a well known stock that had failed an FDA approval. It was down 30% or something and our analyst recommended selling. A family friend of mine owned the stock and so we did what the analyst recommended and I called my family friend and told him to sell. The commission was thousands of dollars. The whole transaction went against everything I believed. I knew I could have implemented the same trade for $0 at Free Trade. I was selling low. But I was doing what our firm believed. When I hung up the phone I felt dirty.

I tendered my resignation a few months later and I started a quest to provide a  low fee financial advisory alternative. That’s what fee compression looks like. And while $0 commissions might not be the ideal way to cut fees it’s a step in the right direction that will have a lasting multiplier effect across many segments of the financial services industry.