The Illusion Of Free

It’s a golden age for investors. Never at any point in history has it been this cheap to get into investing. Management fees and trading commissions have been falling over the past 20 years, thanks mostly to technology which have improved speed and efficiencies of transactions. In the last year or so, the competition over lower fees has been quite intense with ETF companies such as Vanguard and Blackrock going back and forth lowering fees to almost zero. This has trickled down into traditional investment products like mutual funds which have also lowered their fees, albeit less aggressively. Well the race to the bottom in fees has reached a new level.

Free. As in nothing. Nada. Rien.

Wealthsimple and JP Morgan announced they will be offering a trading platform that charges no trading commissions. Fidelity is rolling out ETF products that will charge no Management Expense Ratios (MER’s). The pioneer for this movement has been Robinhood which was the first to offer a zero fee service for investing.

Lower costs or in this case zero costs ensures investors will have more money staying in their pocket which is always a good thing. One of my staple demonstrations when I teach is showing how much of our savings can be lost over a 20-30 period simply due to paying out 1 to 2 percent in transaction costs and administration fees. It’s quite dramatic. Compounding returns is one of the best tools we have to grow our savings meaningfully. It is also one of the best ways to erode our savings if we don’t keep our costs in check. The way things are going, I may have to delete that slide. Along with evaluating the wealth creating potential of an investment, we should always be mindful of the costs of the investment.

It’s a great time to be an investor. Eliminating a focus on fees can allow more due diligence on the investment itself, however I’ve been wondering if these products and service offerings are really free and is free in the grand scheme of things a good thing for investors?

I have a hard time believing that investment companies woke up one day with an epiphany to offer their services for nothing. Aside from the dot com companies for a brief period in the 1990’s, I am not aware of any companies that have been financially sustainable on a business model of charging nothing. There has to be a catch. Something in the fine print.

At some point financial companies have to recoup their costs. One method of cost recovery which Robinhood made popular is charging interest on idle cash that is sitting in customers account. Another is to offer a very limited and finite selection of investment products that don’t appeal to anyone which forces you to upgrade…and pay for a more complete service.

The second method of cost recovery is adopting the Facebook model. Sure it costs nothing to post pictures of your lasagna masterpiece and the summer cottage trip, but we’ve now discovered that Facebook has been selling client data to the highest bidder who are using it to target content, thoughts and products to you. By offering their trading platforms for free, there’s nothing stopping investment companies from building a similar database that can track investor behaviours and trading patterns. This trove of information and analytics then can allow them to develop, and target investment products that they can charge a nice fee for. Taking it another step further, what’s stopping these companies from selling the information to 3rd party financial partners or other fintech firms?

Then there is the behaviours that free can produce. If something is free, we may be more likely to consume it in larger quantities. From an investing perspective, allowing people to endlessly buy and sell stocks for free, could instill people to trade more frequently, and making investment decisions that are more short-term in nature and adopting a trading mentality. Investing becomes more of a game and creates greater opportunities for impulse investing and greater opportunities to stray away from a long-term investment strategy. The opportunities to make bad decisions can escalate. As technology has facilitated lower costs, it can also be a great enabler for this type of trading behaviour.

Whatever approach, the premise is to offer some kind of value proposition that is free and then upsell everything. It has a tinge of those old CD/Record clubs. 10 trades for a penny anyone?

Free may be great, however is saving ½ percent in fees really beneficial to investors who have a hard time staying disciplined to their investment strategy and ideology and reacting to every tremor in the markets going to make much of difference if you end up losing 20 or 30 percent on a bad investment decision? If you can overcome these behavioural headwinds then free can work for you. For most of us, even those that write financial blogs, work in the industry and teach people investing, this is quite challenging.

On second thought, I think I will keep that cost slide demonstration after all.

Aman Raina is an Investment Coach and Founder of Sage Investors. Aman can be reached through his website (www.sageinvestors.ca).