There are many attractive elements to trading your own portfolio. Complete independency and the ability to make your own decisions are enticing. Online programs like RobinHood and WeBull make it incredibly simple to open an investment account and start trading. You can trade almost any equity position you want, and that includes not only buying into a position but also betting against said position by choosing to short the stock. The best part? All of this is offered under the guise of “no-fee” trading, meaning these programs offer the ability to trade for free with no fees attached. Studies have shown that this may not truly be the case.
The first way that these companies profit off your trading is by offering you worse prices than they can obtain. This is almost like a form of arbitrage for these companies. Let me explain. Let’s say you have 100 shares of ABC Corporation stock and you would like to sell those shares. You are on your trading app and you see that ABC stock is currently trading at $20 per share. You choose to sell and redeem the 100 shares at $20 a share resulting in cash value of $2,000. With no trading fees, you take the whole $2,000 which seems like a great deal. The trading company or clearinghouse that you made the trade through, offered you $20 per share, but can actually get $25 per share on that same stock. So, the clearing house makes $2,500 on the sale and takes home $500 after paying you your promised price.
So how can these companies get a better price than you can? Well, while the do-it-yourself trading platforms claim to be in the business of helping the little people, they often actually sell user information and they sell trades themselves. Because of this, both companies involved in a transaction get something they want. Your clearinghouse gets a more desirable price and the other company involved gets your information. The only problem here is that you don’t get anything. Sure you don’t have to pay any explicit trading fee and you get ease of access to the stock market. But, in reality, you are not always getting the best price the market has to offer. This is how these companies make money and stay in operation. A study conducted by the finance department at the University of California Irvine revealed that the true cost of no-fee platforms is about $34 billion dollars a year. This means that normal individual investors are actually missing out on $34 billion dollars’ worth of value when day trading in brokerage accounts that they thought were free to use. While disheartening, the hidden cost of individual trading lies not only in backdoor deals between trading companies but also in the inability of the average investor to beat the market.
Everyone wants to beat the market, that is always the phrase used as a benchmark for portfolio success. This is definitely possible. Your portfolio can beat the S&P 500 index. The caveat is that those who are consistently doing so are not average investors. There can be a bit of an overconfidence among individual investors that they can hang with the portfolio managers and the technical market analysts. This overconfidence leads to unnecessary risks being taken because what worked in the past should work in the future. The human element gets in the way. Irrationality is in fact a cost of no-fee trading. Overconfidence and a lack of confidence alike both cause individual investors to make mistakes that cost them heavily.
That is the point of hiring a financial professional. Much of what we do is educating our clients on making cognitive decisions rather than emotional decisions in their portfolios. We know who we are and we know the incidental destruction we can cause in our own portfolios when we let our emotions take over. It can be costly. When done right, studies show that time in the market results in better long-term results than timing the market. That is what we explain in our planning process. We also know that we are not the experts. When trying to deliver results that exceed the S&P 500, we rely on a group of carefully picked funds and fund managers who actively trade their portfolios based on the trends they are seeing. We are not daily picking equities that we think will get us a win that day, but rather we carefully research for mutual funds that have a history of outperformance and a track record of good management. Our hope is that we can provide our clients with the advice they need to avoid the pitfalls of emotional investing. We try every day to add value to our clients to make sure that the fees we charge are justified.
Thanks for reading (or listening to) this week’s blog. I am heading up north this week to Mackinaw City and the Upper Peninsula! I thought a nice travel tune would be appropriate for today’s song. Enjoy and have a great labor day weekend!
The opinions voiced in this material do not necessarily reflect the views of LPL Financial and are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
All investing involves risk including loss of principal. No strategy assures success or protects against loss.