The Compound and Friends - What Does Commission-Free Trading Mean For You? (with Josh)

Episode Date: October 2, 2019

Josh here - Charles Schwab announced that starting October 7th all commissions on stocks, ETFs and options would go down to zero. The march toward commission-free trading has been happening in slow motion for decades, ever since the 1970's. My take on it is this - it's terrific news for investors, as it lowers the cost of being an investor and gaining access to markets. But is it a "game changer"? I don't think so. It's also important to note the link between market valuations and the ease of access. On a secular basis, US stocks have been valued higher as the average fund fee, commission fee and other costs have fallen. Trading volumes have soared and more participants than ever are using the public markets to build wealth. This is not a coincidence. 1-click play or subscribe on your favorite podcast app   Subscribe to the mini podcast on iTunes or Spotify    Enable our Alexa skill here - "Alexa, play the Compound show!"   Talk to us about your portfolio or financial plan here:  http://ritholtzwealth.com/   Obviously nothing on this channel should be considered as personalized financial advice just for you or a solicitation to buy or sell any securities. Please see this 3,000 word terms & conditions disclaimer: https://thereformedbroker.com/terms-and-conditions/ Hosted on Acast. See acast.com/privacy for more information. Learn more about your ad choices. Visit megaphone.fm/adchoices

Real quick, I couldn't resist. I wanted to weigh in on this thing that Schwab announced today. Starting October 7th, they are going to be making all stock ETF and option trades $0 commission. So free trading on stocks, ETFs, and options. The stock market has had a violent reaction to this news. Schwab is down about 9%. They're giving up roughly, I think, 90 to 100 million in annual revenue or 3% to 4%. I think that's the number. TD Ameritrade is down double, down 21% on the news. I didn't check E-Trade. I'm sure it's a shit show. I just want to make a couple of points here that I think might get lost in the shuffle from an investor's perspective. First of all, this is phenomenal

news. Commission rates for trading have been falling for decades precipitously up until the 1970s. So for 180 years, the New York Stock Exchange had something called fixed commissions, which meant there was a minimum commission that every brokerage house had to charge for every trade. And then in 1970, the chairman saw that he was losing business to other exchanges, capitulated and said, all right, I changed my mind. We might have to revisit this concept of a minimum commission and a fixed commission. And on May 1st, 1975, what's still known as May Day, they announced that negotiated commissions and volume discounts would now be allowed. And right around that time, there was a guy writing a newsletter. I think he was out in San Francisco, Charles Schwab. And he took advantage

of that moment, the elimination of fixed commissions, and started what became the first discount brokerage firm in America. And we know how things went from there. So commissions used to be 5%. Then they were standard 2.5%. When I started in the business a little bit more than 20 years ago, I remember selling a stock to a client and having a 2% commission on the buy. And then even sometimes if you were making a market in the stock as a brokerage firm, there would be an inside spread and the firm would also capture that. So nominally, commissions were 1%, 1.5%, 2%. And then there was even more. And that's just 20 years ago. So the pace of brokerage buy and sell commissions has been precipitously dropping.

And even in business today, we custody, I think, 80% of our assets at TD Ameritrade. They have a platform with over 100 ETFs that trade at no commission. So this doesn't change anything there really. On the Schwab side, I think Schwab is about 12 or 13% of my firm's assets under management. They're custodying 12 or 13%, give or take. So maybe something will change there. But I think it's important just to have the context that bid-ask spreads collapsing, commission rates falling, all of these are great things for the individual investor. One of the things we say back to people when they say, you know, they talk about the stock market valuation and they compare a 16 PE or an 18 PE ratio in today's market versus the 1970s or early 80s when it was 10 or under. It's a

false comparison because the cost of investing is so much lower. So if you're going to say, well, forward-looking returns are going to be low because P-E ratio is historically high, well, yes, but access to the market is cheaper and that offsets that. You're not paying a fixed rate of 2% or 3% every time you buy or sell something. That's a huge, huge amount of money and that should count for something. We also have expanded access to markets as a result of lower commissions. It's not an accident that trading volumes exploded after 1975 concurrent with the fall in the average cost to trade a share of stock. Nobody should be

shocked by that. So I think on balance, this is wonderful news for the individual investor. I understand that the brokerage firms will have to change their business model. They've already been doing that. They're looking to make more money off of things like lending, selling insurance, selling other banking products. By the way, we don't have a publicly traded comp for Robinhood. We don't know what that stock would be doing because it's in the private market. But I think the last round they did was at a valuation of over $7 billion. I'd be curious to see if there were shares trading, if we would still be at those levels. Something tells me

probably not given the adjustment in the public stocks. The last point here, Schwab is going to $0 commissions, but right now they're $4.95 a trade. So in other words, if there's an investment that you would not have wanted to make because the commission was five bucks, and now all of a sudden you think it's a good investment because there is no commission, I think you're missing the big point. That was never really a barrier to entry to doing anything. A $5 trade, a $3 trade, a $7 trade, we should never be doing things just because the cost to execute is lower. And arguably, having a little bit of a barrier maybe isn't the worst thing on earth. But the difference from an investor making a decision to buy or sell

based on five bucks, I don't really think it exists. So I don't think there's a huge amount of change coming. I just think it's a big splashy headline. Schwab saw where things were trending. They wanted to get ahead of it. They did. I think it was a smart business decision.

And now I sit back and I await the phone call from my other custodian providers about how they want to go ahead and match that rate. All right, that's all I have to say. Make sure you're following the channel. Make sure you subscribe to us on YouTube. It's youtube.com slash the compound RWM. We'll talk to you later.