Zero-commission trading: this is what you need to know

Zero-commission trading: this is what you need to know

There are more and more brokers on the market that offer investments in shares, without transaction costs. Existing brokers also advertise more and more with zero commission trading. Most investors are used to paying buying and selling costs every time shares are bought or sold. These costs can become very high over time.

Investing without transaction costs sounds like good news for investors. But is it really? Are brokers suddenly no longer interested in making money on stock transactions? In this article we will discuss transaction cost-free stock trading and what this means for you as an investor.

Zero-commission stock trading

Trading shares without transaction costs seems to be becoming normal. A few years ago the first brokers appeared on the market, offering trading without transaction costs. These were often providers who offered a relatively simple trading platform, with no added value in the form of research and analysis tools or educational material. This is rapidly changing. Many established brokers and banks now offer transaction cost-free trading. At most providers, this only applies to share transactions.

The disappearance of transaction costs and broker fees also has a major impact on banks’ trading activities. The number of professional traders employed by banks has never been as low as in the past year. An important reason for this is the rise in the use of trading algorithms, which are used to make mainly long-term decisions by trading in, for example, ETFs.

Why do brokers offer commission free trading?

There are a few possible answers to this question. A number of brokers and banks have stopped charging transaction fees for equity transactions for competitive reasons. This should also prevent the loss of existing customers. Secondly, brokers often have other ways to make money.

Large brokers offer multiple products and services with which they make money. These include commissions and spreads on leveraged products, interest payments on leveraged products, robo advice, costs for investing in funds, telephone order execution, charting packages and costs for live prices.

Many investors are unaware that brokers make a lot of money by offering orders to so-called market makers. A market maker is the party that actually executes a transaction and makes money on the spread. The spread is the difference between the buy and sell price. Market makers give brokers a fee for offering orders, the so-called order flow. Since spreads are often very small, these are large volumes. Brokers have different options in how they offer customers’ orders for execution. It also happens that brokers sell data from order flow to High Frequency Traders or other market makers. These then use the data to their advantage.

It is therefore not always clear to an investor whether there is so-called “best execution” of orders. In this case always try to look at the spread offered and compare it with the spread published by stock exchanges.

What does transaction cost-free trading mean for investors?

For investors who invest small amounts of money, transaction cost-free trading is certainly an advantage. It allows you to buy one or a few shares without being directly confronted with relatively high purchase costs.

Reinvesting profits and dividends becomes cheaper. Investors sometimes take profit or loss on their shares. In many cases investors also receive dividends on shares, in the form of cash. Often they choose to reinvest released funds back into shares. It goes without saying that reinvesting becomes a lot more efficient, if shares can be bought and sold without transaction costs.

Diversification becomes easier and cheaper. Investors can more easily diversify their portfolio, without having to worry about the minimum cost per purchase.

The amount available for investment increases without transaction costs. The amount that can be saved on transaction costs can make a big difference in returns over the years. Therefore, trading without transaction costs not only saves money, it also makes money.

What should you pay attention with zero-commission trading?

In general, trading without transaction costs is an advantage for investors. However, there are a few things you should bear in mind.

Commission-free trading carries the risk of over-trading. If you do not pay transaction fees on share transactions, you may be tempted to buy or sell shares on a regular basis. However, trading without transaction fees is not a reason to sell shares. Make sure you keep a long-term focus and try to take advantage of the so-called compounding effect of trading shares without transaction costs.

When trading with no transaction costs, always look at the available spread, and compare it with the usual market spread. This way you’ll make sure that your orders are executed on a “best execution” basis. Also consider whether a broker might charge other costs, which may affect the costs you incur.

Keep in mind that transaction cost-free trading often does not apply to all products offered by a broker. So it is always worth comparing the costs of products that a broker charges with other providers.

In the long term, investing in equities often leads to capital growth. We have seen that choosing a good broker can make a big difference to your trading results. In this article you can read more about choosing a good broker.

Conclusion

For the average investor, we see many advantages in investing without transaction costs. As an investor you are more flexible and the savings you make can make a big difference in the long term. On the other hand, investors who do not trade frequently will see little difference in their returns. Of course, there are many more points to think of that you can judge a good broker on. Offering stock trading without transaction costs is therefore not a decisive factor.

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