This week, a few big-name brokerages like Charles Schwab and TD Ameritrade announced they would reduce their commissions on online stock and ETF (exchange-traded fund) trading to zero.
It’s not a completely new concept—Vanguard has promoted free ETF trades for a while, while Fidelity offers zero-fee index funds and ETFs. And some of the newer online brokerages have built their business from the start without trading commissions. Robinhood, for example, which launched in 2012, doesn’t charge trading fees for its smartphone investing app.
But many of the older brokerages make a substantial portion of their revenue from trading fees. For instance, until this week, Schwab charged customers $4.95 to trade U.S. stock, ETF and options trades, the Wall Street Journal reported. (Options trades will cost 65 cents under the new fee structure).
Isn’t dropping fees a bad business move? It may seem like there’s a catch. But in reality, these firms are just trying to catch you as a customer. It doesn’t mean that no-fee trades should be avoided. But you should know where else you may pay to make up for it.
What you should know about free stock trade offers
These brokers are essentially having a sale to draw you in, Nancy Marshall-Genzer, a senior reporter at Marketplace, explained on the Marketplace Morning Report. “They’re competing for individual investors who trade stocks and tend to shop around and these brokers are trying to lure them in.”
It’s like a grocery store, her report explained: You go in looking for the one item that’s on sale, and grab a few other items at full price while you’re there. “So they’re hoping that you will open an account, maybe you’ll sign on with one of their financial advisors, they can charge you a custodial fee for holding the assets in your account. But before they can charge you anything they have to get you in the door,” Marshall-Genzer said.
Before you start chasing commission-free promotions, check out the brokerage’s expense ratio. That’s the percentage of your investments you pay for privilege of holding them in a particular fund. If you’re more focused on sitting tight and watching your investments grow instead of making frequent trades, this is a more important amount to consider.
And remember, brokerages can always change their pricing schemes.