Over the last few years, there has been a race in the investing world to offer the lowest-cost investing options to customers. The result has been that several platforms have started offering commission-free investing, and many of the big, traditional brokers have offered products and services to compete.
Overall, for the individual investor, this is a big win. But it’s not without concern.
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As with anything financial, you need to read the fine print and know what you’re getting into when it comes to free investing. So, before you download the latest free investing app, here are my warnings for people considering one of these investing platforms.
When It’s Free, You’re The Product
Have you heard the saying, “When it’s free, you’re the product”? Well, that’s true in every way online — whether it’s ad-supported tools or investing platforms. Remember, these companies are companies — for-profit entities. They need to make money to support their staff, run their operations, cover their expenses in trading and make a profit. And when they are offering commission-free investing, they have to make money somewhere.
For some companies, that means selling your data; specifically, your order flow and trade data. One such company is Robinhood, which is one of those free investing platforms known for selling customer order flow to hedge funds and high-frequency traders. What this means for you is that other investors will know what you are investing in — before your investments are placed. This can lead to higher prices on execution, meaning you could pay more for the investment, because other companies can buy the stock/option before you have the ability to buy it.
If you’re a buy-and-hold investor for the long run, losing a few cents on an investment position might not matter much to you. But if you’re looking to trade on the platform, and order price execution matters to you, then this could be an important factor in your decision about what platform to use.
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Platform Fees Can Really Be Costly
Many “free” investing platforms aren’t truly free. Instead of charging a commission to invest, they charge a monthly or annual fee, or a percentage of the assets in your account. This could sound like a better deal than paying per trade, but in many cases, it isn’t.
There are several firms out there that advertise things like “Start investing with as little as $5.” While that’s an enticing pitch to encourage someone to invest, these platforms typically charge a fee of $1 per month to invest. So, if you’re only starting with $5, you could easily lose 20 percent of your investing in month one to fees.
Even if you invest weekly at $5, that ends comes out to $260 per year. And if you’re paying $1 per month, that’s $12 per year — or 4.6 percent of your portfolio — in fees.
While that might not sound like much in dollar value fees, considering the stock market returns, on average, 9 percent per year, you’re giving up 50 percent of your potential growth to fees. That’s costly.
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Know What “Other” Fees You’re Paying
It’s also important to remember that commissions aren’t the only fees you’re paying when you invest. Every ETF and mutual fund also charges fees called expense ratios. These fees are worse than commissions because they are charged as a percentage of your investment, and you pay them every year. As a result, they can really drag down your returns.
Many of the free investing platforms have special funds and investments that sound appealing, but they can charge a high expense ratio. For example, if there is an ETF that charges 0.54 percent in expenses, and you invest $1,000 in it, you’ll pay $5.40 per year for each $1,000 in the fund. If your investment grows, so will the amount you pay.
Now, here’s the scary part: If you combine that 0.54 percent per year with a $1 per month fee to invest, you start getting into the “high fee” arena of investing. Suddenly, this free investing platform might not seem like such a worthwhile platform anymore.
The bottom line is that free investing is a good thing for individual investors. But, make sure that you’re investing on a platform that’s truly free. Whether you’re looking to build a low-cost, long-term portfolio, or buy stocks online for free, there are options for you that could make sense.
Even at the major brokerage companies, you can invest with no cost and no fees in certain accounts and products. You just have to do a little homework to figure it out.
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