Explained: Why should investors be cautious about free stock trades? (Peter Lazaroff)

Published on November 21, 2021

Trending guide related to penny Stock Trading Commissions, Penny Shares, Valuable Penny Stocks, Online Trading, and How Can Stock Trades Be Free, Explained: Why should investors be cautious about free stock trades? (Peter Lazaroff).

In this episode, Robert talks to Peter Lazaroff about free stock trades.

Robert Leonard:
You recently wrote a piece about how the new free trades that a lot of brokerages are doing aren’t truly free. Talk to us about this idea a little more.

Peter Lazaroff:
Robinhood 2015 came out and they said, “Hey, we’re not going to charge on stock trades, free stock trades for everybody.” And I I remember going and talking on college campuses and saying, “You guys, you know, that’s not free right?” And they were like, “What? No, I don’t pay anything.” And recently, Charles Schwab and TD Ameritrade and E*Trade, all got rid of their Trade Commissions for stocks and ETFs. And in reality, the cost that I was highlighting in that piece, those have always been there, but like, it’s never free. And my feeling is, if you’re not paying something, then you have just become the product, you know, they are now selling something of yours. It’s kind of like the internet, you know, you go and use Facebook. Facebook isn’t the product. You the user are the product, they’re selling your data, they’re marketing to you. With trading, there are a number of explicit costs, so commissions would have been one of them. But the implicit costs that are there are quite large. So there’s something called a bid ask spread, where if you go to Google Ginance or Yahoo Finance, you’ll find the stock, the current price and you’ll see two prices divided by like a slash sign. And that’s the bid ask price and basically, you know, if you are going to buy a share of a stock for $100, the ask might be $100 and five cents. And so that means it costs you .05% to make that trade. Now you might say, “Oh, it’s just five cents.” But if you’re trading $1,000 worth, well, suddenly it’s not and for a lot of mutual funds, you can buy the entire US stock market and the expense of the fund is point .03%. So this is nearly double what it costs to just own a fund.

So these bid ask spreads, when you trade, it’s really the cost of the market maker executing the trade on your behalf. The other thing is that these custodians, the Schwabss the TD Ameritrade, the Robinhoods, they sell your orders to high frequency traders. So if anyone has read about high frequency traders, they just trade and make fractions of a penny on each share that they trade, but they need orders to be able to do it and so they pay the brokerages for your trade. And you know, that’s how they make money. Other pieces… Sometimes it used to be like, they’ll have platforms where you see it’s kind of like at a grocery store. Mutual fund companies and ETFs, they pay for shelf space and custodians so that you see their funds first, if you’re going to trades, that’s a piece of it. But I think one of the biggest ways that these places are making money is on your cash. So Charles Schwab, for example, nearly 60% of the entire company’s revenue came from cash. So like they charge you, they pay you basically nothing, then they go and lend the money for, say, 2%. And so they just pocket 2%. Plus they charge you money. And ultimately, I could probably go down another half dozen, but they start becoming more opaque. Really, in reality, free trades should not be the reason that you choose a provider at this point. I mean, it used to be that when Charles Schwab launched, I think a discount brokerage trade was like $80. So yeah, it’s obviously a lot better than that. But free trades also might encourage you to trade a lot.

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How Can Stock Trades Be Free, Explained: Why should investors be cautious about free stock trades? (Peter Lazaroff).

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