It’s now free (asterisk) to trade stocks with some popular discount brokerages in the US
Welcome to Plain English. I’m Jeff and your producer is JR. All the resources for today’s episode—including a full transcript for free—are available at PlainEnglish.com/199. I feel like I don’t emphasize that enough. A word for word transcript of everything you hear on this program is available free on our web site, every episode, going all the way back to episode 1. PlainEnglish.com and you can explore all the old episodes.
Coming up today: This is incredible, but you can now buy and sell stocks in the US without paying any type of broker commission. I’ve had some people ask, why don’t you do an episode about finance and investing? And I haven’t because I just wasn’t sure whether it would appeal to most people who listen. Not like taking a nap at work! That one has universal appeal!
Related: Episode 194: Naps popular with Japanese office workers (just not always in the nap room)
But I thought this was a good way to get some finance and investing vocabulary into Plain English. Even if you’re not an active investor, I think you can learn some good business words in today’s episode. The English expression is “follow suit.” And we have a song of the week, since it’s Thursday.
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Race to the bottom in stock commissions
Twenty years ago, if you wanted to buy stock in a public company, here’s what you had to do: You had to call a person, who was wearing a suit, sitting in an expensive office, probably in New York. You had to tell that person what you wanted to buy. He would buy that stock on your behalf, and charge you fifty dollars. Go back another ten years and it would have cost you two hundred dollars. That person is called a broker—he (and it often is a “he”) matches the buyer with the seller. And the company he works for is called a brokerage.
Today, you can log into your online brokerage, at any time of the day, and with a few clicks of the mouse, you can buy a share of stock in the US or, increasingly, on many global stock exchanges, at any time of day, with no human involvement. And starting this month, it’s free.
Charles Schwab became the first brokerage firm to offer free trades to its clients; other discount brokerages like E-Trade and TD Ameritrade followed suit. What once required a phone call and $200 or more, is now free. Well, like many things that are free, there are some strings attached. We’ll get to those in a second. But first, let’s talk about why this is a pretty big deal.
If you have money to invest for the future, owning stock, owning shares in a public company, is a good long-term investment. By owning shares, you own a tiny portion of that company. That share often goes up in value as the company generates more profit in the future. Obviously that doesn’t happen with every company, every year; but if you own enough shares in different types of companies, you will do well over the long run.
The problem has always been that it’s difficult for someone with a smaller amount of money to own enough different types of shares to have a balanced portfolio of stocks. You don’t want to invest all your money in just one company because that one company can fail; that’s why you want to spread your investments out among multiple types of investments. But every time you buy something, it costs money. If you have $1 million to invest, then the costs of buying and selling large amounts of stock are pretty low in comparison to what you have. But if you have only $1,000 to invest, then the costs of buying just $100 of stock in one company are high, in percentage terms. If you pay a $10 commission, that means you’re already losing 10% of your investment just in the transaction costs.
Secondly, let’s say you decide a year later that you want to change your investment for something else. That would cost $10 to sell your stock, and $10 to buy a new one with the proceeds. This is awfully expensive in percentage terms if you aren’t investing a lot of money. Of course, it was even worse when it cost $50; but it’s still bad enough when it costs $10.
When I first started to save money and invest for the future, a single stock trade cost $15, and that was considered revolutionary back then. Then I switched to E-Trade, which was, at the time, $10. I think it was as low as $7 recently. And now it’s free.
Here are the ways it will benefit smaller investors. Let’s say you save a little bit of money every month and you’d like to invest it little by little. You might have a lot money saved up in total, but if you want to add just $100 per month in stocks—it wouldn’t make sense to do that if you have to pay $10 just for the privilege of buying. With high costs, it’s better to wait until you have a larger amount saved up. But free trades would let you incrementally add to your investments without worrying about those costs.
Rebalancing is also a common term in investing. After a while, some your investments will have done well; some will have done not as well. The economy may have changed. Your life situation may have changed. It makes sense to periodically look at what you’ve invested in, and rebalance it; shift some things around. Make sure that it still reflects your priorities. Sometimes, as a smaller investor, I would want to shift things around a little bit. Nothing drastic, just sell a little of this, buy a little of that. But sometimes it just wouldn’t make sense because of how much it costs to buy and sell. With free trades, investors can rebalance whenever they like, and with whatever amounts they like.
There is a danger to this. We can complain about transaction costs, but one thing they did was, they made us stop and think if a trade was worth it. Now that every trade is free, investors are free to buy and sell stocks every day. And that’s the danger. Unless you’re a true expert day trader, then buying and selling whimsically is an easy way to lose a lot of money.
I mentioned at the top of the episode that there’s an asterisk. An asterisk is the little star you see next the huge word FREE! The brokers who are offering free trades are not doing this out the goodness of their hearts. If we’ve learned anything about Wall Street, right! They are going to make their money—just in other ways.
One way they want to make money is to tempt smaller investors to switch to their platform, and then charge them money for other services. That’s fine; there’s nothing wrong with that. Giving something away for free in the hopes that some people buy a premium product is a perfectly legitimate thing to do in business! Wink, wink.
But any time you get something for free, you have to always think about why it’s free. Here’s another way a brokerage would make money by giving away free trades. And this is a little tricky. Most investors will have money that they invest, but they also have some of their money in cash. And by cash I mean, not physical cash, but in a bank account. In investing terms, we say “cash” is any money in the bank that’s not invested in something else.
So anyway, a lot of these investors that offer you “free” trades will also let you store your money in a bank account. How nice of them! But that bank account won’t earn very much interest, even if traditional bank accounts with other banks do. That’s what Charles Schwab does. People will move their money there, without realizing that they’re not earning interest on money in their account that’s not in the stock market. Charles Schwab is “making” money here by not giving you a good rate of interest on your cash. It’s not illegal; it’s not unethical; but it is a little tricky, in my opinion.
Like many innovations, there are great things about free stock trades, but some things to be wary of. I hate it any time there is something standing in the way of someone who wants to buy and someone who wants to sell, so I’m happy that stock trades are now free.
One thing I don’t know is how this works outside the US. I’d love to know whether you can buy or sell stock for free in your country—or how much it costs. Hopefully the trend here spreads worldwide, for all the small investors out there.
I want to say thanks to Victor, who sent me an article about Japan. He found this article that said car rental agencies would get cars back from customers and discover there were no more miles on the car than when they had left the lot. What’s up with that? The Japanese people were renting a car, driving it around the block, taking a nap in the car, and returning it! They need to be in the nap room. Thanks for the article, Victor!
Secondly, Juanita from Colombia found the episode about the cyclist Egan Bernal.
Related: Episode 182: Colombian cyclist is the first to bring Tour de France’s yellow jersey to Latin America
Glad to have you with us Juanita. Andrés from Colombia is studying electrical engineering and practicing English and French on the side.
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