Many musical artists have told us the best things in life are free – think of Frank Sinatra crooning about flowers in spring and robins that sing and Jennifer Lopez saying that love don’t cost a thing. And we’re all familiar with the many tunes in homage of another freebie cherished by a growing number of investors: commission-free trading and commission-free ETFs … right?
OK, so maybe commission-free trading and commission-free ETFs don’t inspire your inner songwriter. (Though we’d love to read your lyrics in the comments section if you care to share.) But these two investment options continue to increase in popularity as numerous brokerages — including Ally Invest — expand their commission-free offerings.
But what, exactly, does commission free mean? What are commission-free ETFs? And, perhaps more importantly, what the heck is a commission?
Let’s dive in and discover how commission-free trading can be part of everyone’s portfolio.
Let’s talk about commissions.
Commissions are simply the fees your brokerage could charge every time you buy or sell a stock or exchange-traded fund (ETF). Think of it as a built-in tip for your broker for helping you facilitate the trade.
Commissions are the same thing as paying for a service. If you don’t have time to mow your lawn, you toss your neighbor’s kid $20 a week to do it. If you don’t know how to change the oil in your car, you go to your local mechanic.
There are two types of commissions: percentage and flat rate. Standard percentage commissions could be around 1% of the trade, while flat-rate commissions are typically less than $10 per trade. Hypothetically, that may not sound expensive, but it can quickly add up — especially for active investors who regularly make trades.
Using flat-rate commissions as an example, let’s say you buy or sell one stock or ETF every day for a year. Since there’s an average of 252 trading days annually, that means you’re charged a commission on each of those 252 trades. An average commission of $4.95 would cost you $1,247.40 in fees, while a higher-priced commission of $7 would equal $1,764.
Like flat-rate commissions, percentage commissions are added to your trade once it’s completed. So, if you buy 20 shares of Stock A for $47 each, or $940 total, you’ll end up paying $949.40 total after a 1% commission. If you make similar-priced trades twice a month for a year — and pay around $10 per trade — you’d pay $240 in commissions.
Of course, the goal of investing is to come out ahead. And hopefully those commissions — whether you pay less than $240, more than $1,764, or somewhere in between — are a relatively small portion of your overall profit. But you’ve still spent hundreds and potentially thousands of dollars on commissions. And that’s a sad tune, for sure.
Why why why?
So why do investors allow themselves to be charged pricey commission fees?
Well, many everyday people feel they don’t have the stock-market know-how or the time to make informed investing decisions, so they go to a brokerage and choose a financial expert to manage their portfolio for them. But that expertise doesn’t come free, and in fact, charging commissions is how brokerages — and brokers — make the majority of their profits.
Historically, there have been two types of brokers: Full-service (or traditional) and discount.
Hiring a full-service broker is like ordering a hamburger with everything. You get the works: assistance in buying and selling stocks, financial and retirement planning services, investing and tax advice, etc. Discount brokers, on the other hand, are like a build-your-own salad bar. They give you access to just what you want: their trading platform and the ability to choose investments on your own, but offer little-to-no advice.
As you’ve likely guessed, discount brokers typically offer lower commissions than full-service brokers. But for many years, hiring a full-service broker was the smartest choice for investors because regular people lacked access to the information used by brokers to make sound decisions on their own. Then the internet happened.
A whole new world
The world of finance was forever changed by the connectivity and access to information that the internet provided. Which has proven to be cost-effective for savers and investors alike.
Going online and avoiding the typical brick-and-mortar full-service brokerages has allowed modern online banks and brokerages to incur fewer expenses and, as a result, offer more to their members while also charging less. For example, Ally Invest has several commission-free offerings through its Self-Directed Trading.
So what does commission free really mean? It’s all in the name. Commission free means that you don’t pay any commissions on your trades. And when you don’t have to pay commissions, you have more money left over to invest.
While do-it-yourself investing might sound intimidating, it’s easier than ever thanks to technology. The internet has empowered everyday investors with access to the same detailed market and stock information — historical data, daily movement, etc. — that was previously only available to those on Wall Street. This has led some investors to move away from full-service brokers and instead invest on their own through discount brokers.
On your way to commission-free investing
If you don’t feel comfortable buying and selling stocks and ETFs on your own, that’s okay. How to invest and plan for the future are personal decisions that should not be taken lightly.
But as Lopez sang, money can’t always buy the things you need. If you feel confident trading without the help of a financial advisor, check out commission-free offerings available from an online brokerage like Ally Invest. They can be a great strategy to help make your portfolio really sing.