Finance

Schwab-Ameritrade Merger Creates Discount Trading Giant

Merger Solidifies Move to No Fee Online Trading

As anticipated, the Charles Schwab and TD Ameritrade merger completed early in November 2020 – or at least the paperwork and the regulatory nod making the merger a go – creates a titan in the online brokerage business with three quarters of all assets under management in the United States (approximately $5 trillion) now theoretically under one umbrella.

A year ago, the announced merger was preceded by Schwab and TD slashing online trading fees to zero. Other online trading platforms including closest competitor, E-Trade, quickly followed suit.

The race to zero fees began in 2017 when newcomer, Robinhood, opted to profit from trading options and interest rather than on commissions paid by the users of its platform.
While no fees for online trades is an enticing idea, it is not exactly a guarantee that investors do not or will not pay fees related to those online trades.

The reality is quite different.

Online trading fees – the ones that have dropped to zero with just about every trading platform – are classified as visible fees. Theses are fees that consumers easily recognize.

The Fees You Don’t See Right Away

The hidden fees – the ones that only educated consumers know about, recognize and understand how they impact the cost of trading – are where trading platforms now make the money.

no fees 400x600Perhaps the one most missed by online investors is the “Bid-Ask Spread.”

It really isn’t new; it just is playing a more prominent role in how online platforms make up the significant losses of providing online users with zero-dollar trades.

“Bid-Ask Spread” is a tool used by brokers to determine the amount of market liquidity each stock represents. It is the difference between the highest price a buyer is willing to pay for that stock and the lowest price a seller is willing to accept.

Simon Moore, investing correspondent for Forbes, explains how a widening of the bid-ask spread helps online platforms recoup the loss of trade commissions.

“You may have noticed that when you trade a stock in your account, you almost instantly lose money compared to the market price,” he explained in an October 2019 article shortly after Schwab and TD zeroed out online fees. “This is because of bid-ask spreads; to compensate the market maker for constructing a market in a stock, you (the investor) typically don’t receive the market price when you buy or sell. You pay a little bit more than the prevailing price when you buy and receive a little less when you sell. Of course, the brokerage may provide an unattractive spread for you regardless of fees, but the absence of trading commissions means that less efficient trading could be a way for brokerages to capture revenue from trades in a way that is less obvious to the customer, such as routing trades in a way that leads to wider spreads.”

And while investors cannot control the “spread,” they can control which bid-ask scenarios they opt to engage.

Chad Shoop is an income and investment research expert with Banyan Hill based in Baltimore, Maryland. He encourages investors to investigate the “bid-ask spread” before entering into an agreement to buy or sell.

“Many options are listed too high, and if you don’t do the research, you’ll quickly be sucked into overpaying for the trade you want to make,” he warns.

Other Costs That Are Not Going Away

Of course, every business has operating costs.

The nearly completed race to zero trading fees is not going to end the cost of doing business.

In the ETF world, this cost of doing business is know by the acronym, OER (operating expense ratio). Every ETF has one that is not set by the broker selling the ETF but by the fund itself to cover the cost of annual administration, portfolio management and other miscellaneous costs.

It is listed in the fund’s prospectus, but as most of us are aware, the full reading of a fund’s prospectus by an investor is not just a rare thing: It just does not happen.

That does not mean that an investor cannot ask or should ask their broker to explain what the OER is. It is just one more piece of information to help investors make a more informed decision regarding which fund to select.

Another expense not going away just because online trading fees have is the discounts and premiums to NAV (net asset value). While this might sound similar to the Bid-Ask Spread, it is a different measure of the expense associated with each ETF fund. The discounts and premiums cost is the amount below or above its NAV that the fund is currently trading.

No Such Thing as a Free Lunch or ETF

Industry analysts expressed concern that the no online trading fees will prompt users of these platforms to trade more than they would have otherwise and to trade on ETFs they might not have before the race to zero fees.

“Free trading is great,” the Financial Samurai wrote in an October 2019 article advising online traders on how online platforms make money in a zero-dollar fee trading structure. “But just as getting fries for free sounds great, if you subsequently also buy a Big Mac, a 16-ounce Coke and a baked apple pie, you have probably spent too much on an unhealthy meal.”

 

 

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