Commission-Free Trades: Watch Out!

Schwab was the first to introduce commission-free trades a month or so ago, and the other major discount brokerages quickly followed suit. Now anyone who has an account at one of these firms can trade as much as they want with no transaction cost. Sounds great, right? What could go wrong?

Beware when someone offers you something for free!

Over-Trading

A lot can go wrong. First of all, most real money that is made in the stock market is made by buying and holding quality positions for a long period of time. Frequent trading can be profitable for a short time but it is very difficult to make money by trading all the way to the top. This is the Efficient Markets Theory in action. You might ride a hot streak for a while, but eventually returns will revert to the mean over the long term.

“Popular” Stocks

Another side of this is that no commissions might cause investors to invest more in the “popular” stocks of the day. This type of momentum-based trading can work out for a while, but as with popular culture, the fall from grace can be violent and swift. This is why especially amateur traders don’t make real money in the market: they buy what is popular when it is expensive and then they sell when the popularity turns.

Poorer Corporate Governance

Another ramification is that corporations may become less accountable to their shareholders. If their shareholders are only temporary squatters, then there is less motivation for corporate management to run a clean house. Long-term investors tend to be more committed to keeping a management team in check. Although it is not yet a publicly-traded company, witness SoftBank’s jerk of WeWork’s collar. This happened as a result of SoftBank’s long-term investment in WeWork.

IMO

My point is to encourage investors not to give in to the temptation to increase their level of trading in their accounts just because there are no commissions on trading. The formula for successful long-term investing have not changed, and investors need to keep to the formula. Don’t get into any bad behaviors in your own accounts!

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