When discount brokerage firms like Charles Schwab, E*Trade, and TD Ameritrade emerged on the scene, they made stock trading more affordable. The trade commissions in the sub $20 range were a refreshing change from the exorbitant fees traditionally charged by full service brokers. If that was good, now it must be great with firms like Zecco touting “$0 Stock Trades” — or is it?
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Obviously, a low trading fee is great if you don’t trade more as a result — you will definitely save more money by working with low trading cost firms like Zecco. However, a $0 stock trade is NOT really free. The trade commission you pay when you buy or sell shares of a stock is just the tip of the iceberg. Below the surface is a hidden fee called bid-ask spread, that is, the difference between the price that someone is willing to sell you shares (ask price, higher) and the price that someone is willing to buy from you (bid price, lower) . You pay about half of this spread when you buy and the other half when you sell. So, the spread is effectively the hidden cost of a full buy and sell cycle.
For example, let’s look at this table.
If I invest $10,000 in JPMorgan Chase & Co (JPM), I’d have to pay $46.99 per share and receive 212.81 shares. In theory, I lost $95.77 the minute this trade is executed, because I’d only get $46.54 per share if I wanted to sell them back. What happens to the $95.77? This is the spread, and it is kept as profit by the market maker handling the transaction.
Like I said before, everything is great if the behavior does not change because of the lower trade commission; however, I doubt this is the case for most investors. For example, if I normally buy and sell once per year when I had to pay $10 commission, then I am out $115.77 for the year to buy and sell JPM ($10 to buy, $9577 for the spread, and $10 to sell). However, let’s say the lower trading fee changed my behavior. I now buy and sell 4 different stocks in the same year — i.e., JPMorgan Chase (JPM), Staples (SPLS), Microsoft (MSFT), and Google (GOOG) — in this case, I am out over $180 for the year.
Before you make your next trade, be sure to take the bid-ask spread into account. This is also why long-term buy and hold strategy is better than frequent trading — it takes less gain to overcome the expenses.