The Real Cost Of No-Commission Stock Brokers + Why Are Some Cheaper Than Others? — My Money Blog

In a recent study, the authors opened accounts at six different brokerages with their own money and executed 85,000 market orders. They uncovered some interesting details about the true costs of trading using “commission-free” stockbrokers. Here is the research paper The “true retail price” of equity transactions as well as coverage by WSJ and Matt Levin. Some takeaways:

“Zero commission” does not mean “free” trading. There is always a cost due to the difference between the buying and selling prices (bid-ask spread). If you bought and sold again the exact same share of stock immediately, you will almost always end up with less money than before. For example, you could buy a stock for $100 but only be able to sell it for $99.95.

How many? The study found that the average round-trip trade cost ranged from -0.07% to -0.46%; the average price improvement ranged from $0.03 to $0.08 per share (value around $100). If you’re an individual buying a low-cost index ETF and holding it indefinitely, that’s still a small concern.

Big traders still face an uphill battle. However, if you trade repeatedly for an extended period of time, the transaction costs of your “free” trades will still add up fairly quickly and your chances of profit will decrease significantly. Here’s what happened when they continued to trade $100 back and forth on Interactive Brokers Pro and TD Ameritrade.

In fact, the authors of the article had to reduce their standard trade size from $1,000 to $100 because they knew they were going to lose too much money (their own). (They first confirmed that transaction costs in terms of percentages were basically the same for trade sizes of $100, $1,000, and $5,000.)

The difference between the “best” and the “worst” broker was 5 cents per $100 round trip trade. Will the average individual trader switch brokers beyond this amount? I would appreciate things like customer service over that small cost. Yet if you add up all the transactions that occur over the course of a year, that’s billions of dollars. somewhere. Here are the six ranked brokers (chart via WSJ article).

The study found almost no relationship between the amount of payment for order flow (PFoF) accepted and lower execution prices. In fact, IBKR Lite is the branch of Interactive Brokers that accepts payment for order flow (PFoF), while IBKR Pro does not accept any PFoF. Still, IBKR Pro had the worst execution for authors’ $100 trades.

The strangest discovery is that market makers give different prices to different brokers for the exact same trades. This is the “industry secret” they have discovered. One implication is that each broker trades “when” the market maker overcharges or undercharges you based on their customer base. For example, Interactive Brokers implies that their “Pro” clients have larger average trade sizes, and therefore they can offer these types of clients better execution (while giving smaller trades worse prices, hence their poor performance in this study).

Bottom line. The PFOF might not be a huge deal for an individual investor, but there are still billions to be made by skimming pennies on every trade, and so weird shenanigans arise. However, if you are an active trader, there is always a stable transaction cost for each stock trade. How many people do you know who got rich by buying and selling stocks hours, days or weeks later? I certainly don’t know of any. During this time, I noticed the following in my public app’s stock feed (see transfer bonus) for Berkshire Hathaway. I’m sure there may be good reasons in some cases, but it’s concerning how short those holding times are for a stock like Berkshire, which is designed for long-term patient ownership.

Dolores W. Simon