Zero commission: What does zero commission trading mean?

Today, buying and selling securities can be done with zero commission fees charged on your account. Most major online brokers have removed commissions on online stock transactions.

But why did these brokers suddenly decide they didn’t want to earn commissions on stock trading? And how is this beneficial for you as an investor?

When Robinhood started with the idea of zero-commission trading a few years ago, it seemed like a disruptive endeavour, but not necessarily one that would spread throughout the investment industry.

After all, Robinhood has a relatively simple platform, and many investors find value in educational tools, stock research, and access to specialized brokerage account types.

What is zero commission trading?

Commission-free investing eliminates transaction fees, which can range from 5 to 50 euros with some brokers, depending on the services and securities offered. This removal significantly impacts overall profit margins.

Commissions vary based on trade size, timing, market, and strategy, affecting both retail and institutional investors. Hence, brokers offering commission-free trading appeal to everyone.

This trend has surged in recent years, pioneered by Robinhood. Such brokers, attractive to beginner investors with limited capital, have shifted their pricing model to maintain market share.

Investment advice – What zero commission trading means for investors

The emergence of zero-commission stock trading is certainly a win for investors, especially newbie investors with limited capital.

On the one hand, it makes it convenient to buy small quantities. For example, let’s say a stock is trading at $100. With a €6.95 commission, you would essentially pay a 3.5% premium to buy a stock, which is impractical from a cost perspective.

Or, if you receive a €50 dividend from a stock, it wouldn’t be practical to pay a commission to invest that money – you’d either have to enrol in a dividend reinvestment plan (DRP). This would automatically reinvest dividends in the same stock that paid them, or let your cash flow accumulate in order to invest your dividends profitably. This is much less of a concern.

Simplifying Diversification for New Investors

Similarly, commission-free trading facilitates diversification, particularly for novice investors. Starting with €1,000, you can easily allocate your funds across a diversified portfolio of five or more stocks.

Without the burden of commissions, which could devour around €35 of your capital (or even more), you can confidently navigate the realm of stocks and shares.

Is zero-commission stock trading beneficial for investors?

Here’s a brief illustration of its impact. Let’s say you plan to invest $1,000 annually, splitting it among five stocks. Assuming a commission of €6.95 (about €35 per investment round), and a 10% annualized return, paying commissions means investing only €965 each time.

Over 10, 20, and 30 years, your portfolio could grow to approximately €15,400, €55,300, and €158,700, respectively.

However, with a platform offering commission-free trading, you can invest the full €1,000 each time. Despite the seemingly small commission of $6.95, its absence can significantly affect your portfolio.

Also, over 10, 20, and 30 years, commission-free investing could yield an additional $560, $2,000, and almost $5,800, highlighting the substantial benefits of such platforms to investors.

How do zero commission brokers make money?

It’s understandable why zero commission trading is attractive to investors, but how do commission-free investing brokers make their money? The commission-free movement has forced brokers to engage in other activities to make money.

Payment for order flow

Payment for order flow is a key revenue stream for commission-free brokers. They sell order flow to market makers, who profit from providing liquidity for various securities.

Market makers often capitalize on retail order flow, potentially disadvantaging investors by leading to higher buy prices, subpar order execution, and lower sell prices.

This practice, while lucrative for brokers, can compromise trade quality and bolster brokerage profits through order execution delays.

Payment for order flow became a significant revenue source for brokerage services in 2020. Notably, TD Ameritrade earned $526.59 million and Robinhood $271.2 million from order flow payments in Q2 2020.

How brokers monetize zero-comission trades?

This process underscores how brokers monetize zero-commission trades, highlighting its importance in their revenue model.

Additionally, some brokers offer features like demo accounts and free stocks to attract users, enhancing their competitiveness in the market.

Margin loans

Large brokers practicing commission-free trading promote liquidity by investing excess cash in securities or lending it out, akin to banks.

Additionally, they offer “cash management” accounts resembling savings accounts, where clients’ funds are transferred to partner banks for interest earnings, with brokers retaining most of the interest.

Alternative revenue sources may include monthly fees for premium services and remortgage, leveraging clients’ securities as collateral for financial activities, potentially affecting the financial system under stress.

Zero commission brokers – how to choose one and start investing

How to Compare Zero Commission Investing Brokers

These days, most brokers offer free trades in one form or another. As with any investment, knowing what you’re getting into and choosing the right broker is essential to get the most out of investments and avoid hidden fees.

Therefore, traders should go beyond zero commission investing and do more research on other factors such as analytical tools, strategy support, and trading platforms.

So here are some key points to consider when choosing brokers that offer you to invest in the stock market and other markets with zero commission.

Trading platform

Brokers that have easy-to-use interfaces are great for all traders, especially beginners. The most popular third-party trading platforms are MetaTrader 4 and MetaTrader 5, which offer a good balance between advanced features and intuitiveness.

However, many brokers offer their own platforms and apps, often stripped down to be more user-friendly, and these can be great for newbie traders.

Markets

Some brokers, with zero commission investing, offer the option of buying fractional shares, which is particularly appreciated by new investors.

Other platforms also allow users to trade contracts for difference (CFDs), which allows you to speculate on the price movements of securities such as stocks, cryptocurrencies, index funds, exchange-traded funds and commodities, mutual funds.

Choosing one of the many multi-asset brokers offering commission-free investing means you can diversify your trading portfolio at a lower cost.

Costs

When a broker offers zero-commission investments, it means they waive their own fees for executing trades. However, other expenses like exchange fees should still be considered for maximizing returns.

Commission-free brokers may levy additional charges such as withdrawal fees, inactivity fees, overnight swaps, and subscription fees.

Security

Select a licensed broker regulated by reputable authorities like the UK’s Financial Conduct Authority (FCA) or the EU’s Cyprus Securities and Exchange Commission (CySec). Identity verification and features like two-factor authentication and biometric IDs enhance account security.

Minimum deposit

While opting for commission-free brokers is enticing, consider limitations such as minimum deposit requirements. Brokers with no minimum deposit may suit novice traders, whereas experienced traders might prefer those with higher minimum deposits.

Customer support

Evaluate the accessibility of your broker’s customer support. Check if they are reachable via phone, email, or social media platforms like Twitter or Telegram. Reliable and responsive customer service is crucial, especially during critical trading situations.

Bottom line

Zero commission trading enables investors to trade securities without paying commission fees, a trend growing among major online brokers. It reduces transaction costs and facilitates smaller investments or dividend reinvestment.

Commission-free trading appeals to both novice and experienced investors, but additional expenses like exchange and withdrawal fees should be considered.