Zero commission: What does zero commission trading mean?

Today, buying and selling securities can be done with zero commission fees charged on your account. Most major online brokers have removed commissions on online stock transactions. But why did these brokers suddenly decide they didn’t want to earn commissions on stock trading? And how is this beneficial for you as an investor?

When Robinhood started with the idea of zero-commission trading a few years ago, it seemed like a disruptive endeavour, but not necessarily one that would spread throughout the investment industry. After all, Robinhood has a relatively simple platform, and many investors find value in educational tools, stock research, and access to specialized brokerage account types.

What is zero commission trading?

Commission-free investing means that there are no fees to complete a transaction. With some brokers, commissions are usually between 5 and 50 euros, depending on the services and securities offered on the stock market, so removing them can really make a difference.

Commission-free trading relieves investors of one of the costs that ultimately reduce their overall profit margin. Commissions can vary depending on a range of factors, including the size and timing of a trade, the market you are investing in and the strategy you are using, the long term or the short term. For retail investors, the cost of a transaction is mainly reflected in the amount of the commission. However, the cost of commissions can affect both retail and institutional investors. Therefore, brokers who offer commission-free investments can be an attractive option for everyone.

The tendency of brokers to offer zero commission transactions has increased in recent years. Commission-free investing was pioneered by Robinhood, and since then, other high-profile brokers have reconsidered their pricing model to continue attracting and retaining customers, as well as their market share. Brokers offering commission-free investing are particularly attractive to younger or newer traders who generally have less money to invest.

Investment advice – What zero commission trading means for investors

The emergence of zero-commission stock trading is certainly a win for investors, especially newbie investors with limited capital.

On the one hand, it makes it convenient to buy small quantities. For example, let’s say a stock is trading at $100. With a €6.95 commission, you would essentially pay a 3.5% premium to buy a stock, which is impractical from a cost perspective. Or, if you receive a €50 dividend from a stock, it wouldn’t be practical to pay a commission to invest that money – you’d either have to enrol in a dividend reinvestment plan (DRP), which would automatically reinvest dividends in the same stock that paid them, or let your cash flow accumulate in order to invest your dividends profitably. This is much less of a concern.

Along the same lines, it makes diversification easier for new investors. If you start with, say, €1,000, you can invest your money in a portfolio of five more stocks quite easily, without having to worry about commissions that might eat up your capital by €35 (or more).

Is zero-commission stock trading beneficial for investors?

Here’s a quick example of how it might affect you. Suppose you want to invest $1,000 per year in the near future, and you want to split your money between five stocks. We’ll also say that you used to pay a commission of €6.95 (about €35 per round of investment), and your investments will earn you a 10% annualized return over time.

If you pay commissions, this means that you are effectively investing 965 euros each time and not the entire 1,000 euros. According to our assumptions, you could expect to have a portfolio worth approximately €15,400 after 10 years, €55,300 after 20 years and €158,700 after 30 years. Not bad, isn’t it?

However, if you do not pay commissions, it means that you can use the full 1000 euros each time. Although $6.95 in commissions doesn’t sound like a lot, you might be surprised at the difference it makes. After 10 years, a commission-free investment will result in an additional $560 in your portfolio. After 20 years, you’ll have $2,000 more, and after 30 years, you’ll have almost $5,800 more than you would have had if you had paid commissions. This is why commission-free stock trading is so beneficial to investors.

How do zero commission brokers make money?

It’s understandable why zero commission trading is attractive to investors, but how do commission-free investing brokers make their money? The commission-free movement has forced brokers to engage in other activities to make money.

Payment for order flow

Payment for order flow is one of the primary ways commission-free brokers make money. Smaller brokers sell order flow to exchanges or market makers who in turn generate revenue by providing liquidity for different securities. Market makers make more money by trading against retail order flow.

However, this can be to the detriment of investors. To make money from commission-free trading, the order flow payouts used by brokers can lead to higher buy prices, poor quality order execution, and lower sell prices. Delays in the execution of orders can create opportunities to damage the quality and increase commission-free brokerage profits.

This is a primary way that brokers make money from zero-commission trades. It was a growing source of revenue for brokerage services in 2020. TD Ameritrade got $526.59 million for order flow in Q2 2020. Robinhood made $271.2 million from order flow payments during the second quarter of 2020.

Margin loans

Large brokers who practice commission-free trading also encourage the influx of liquidity. These brokers can take excess cash and invest it in securities or lend it out, as banks do. Brokers have also started offering “cash management” accounts, similar to savings accounts, where customers’ money is transferred to partner banks where it can earn interest. Brokers make money by keeping the majority of this interest for themselves.

Sources of profit other than margin lending could include monthly fees for enhanced services and remortgage, which allows brokers to use clients’ securities as collateral to cover other financial activities. Thus, this can have consequences if the financial system is under pressure.

Zero commission brokers – how to choose one and start investing

How to Compare Zero Commission Investing Brokers

These days, most brokers offer free trades in one form or another. As with any investment, knowing what you’re getting into and choosing the right broker is essential to get the most out of investments and avoid hidden fees. Therefore, traders should go beyond zero commission investing and do more research on other factors such as analytical tools, strategy support, and trading platforms.

So here are some key points to consider when choosing brokers that offer you to invest in the stock market and other markets with zero commission.

Trading platform

Brokers that have easy-to-use interfaces are great for all traders, especially beginners. The most popular third-party trading platforms are MetaTrader 4 and MetaTrader 5, which offer a good balance between advanced features and intuitiveness. However, many brokers offer their own platforms and apps, often stripped down to be more user-friendly, and these can be great for newbie traders.

Markets

Some brokers, with zero commission investing, offer the option of buying fractional shares, which is particularly appreciated by new investors. Other platforms also allow users to trade contracts for difference (CFDs), which allows you to speculate on the price movements of securities such as stocks, cryptocurrencies, index funds, exchange-traded funds and commodities, mutual funds. Choosing one of the many multi-asset brokers offering commission-free investing means you can diversify your trading portfolio at a lower cost.

Costs

It is important to remember that when a broker offers a zero-commission investment, it means that they are not charging their own fees to help them execute the trade. At the end of the day, there may always be other costs, such as exchange fees, and it is essential to consider them carefully to get the most out of your investments and your returns. Commission-free stockbrokers may also charge withdrawal fees, inactivity fees, overnight swaps, and subscription fees.

Security

We recommend choosing a licensed broker that is duly regulated by a reputable organization, such as the UK’s Financial Conduct Authority (FCA) or the EU’s Cyprus Securities and Exchange Commission (CySec). Some brokers require identity verification upon registration, which is an added protection. Two-factor authentication (2FA) and biometric IDs for mobile apps can also be a great way to reduce the risk of accessing your account and funds.

Minimum deposit

It’s fine to choose brokers who invest commission-free, but be aware of limitations such as minimum deposit and whether this makes the broker unreachable. Brokers with no minimum deposit may be more suitable for novice traders, while more experienced traders can afford a higher minimum deposit.

Customer support

If you need help, how reachable is your broker? Are they available by phone and/or email? Are they on social media platforms like Twitter or Telegram so you can reach them if not? Reliable and responsive customer service is essential when choosing a zero commission broker. No one wants their account to go down while a large trade is in play and needs to be closed before causing major losses.