**Four Hidden Costs of Zero-Commission Brokers โ€” Transcript & Summary | SozAI** Source: https://sozai.app/transcript/hidden-costs-zero-commission-brokers/ Explore the hidden costs of zero-commission brokers and how they impact investors beyond the apparent free trades. ## Key Takeaways - Zero-commission brokers are not truly free; hidden costs reduce investor returns. - Bid-ask spreads and foreign exchange fees are significant cost factors. - Payment for order flow can create conflicts of interest affecting trade execution. - These brokers democratize investing but require investor discipline and awareness. - Understanding these costs helps investors make better-informed decisions. ## What the video covers - Zero-commission brokers like Robinhood and Wealthsimple Trade allow commission-free trading but have hidden costs. - The bid-ask spread acts as an implicit trading fee, especially significant in less liquid stocks and options. - Foreign exchange fees apply when buying stocks in a currency different from the account's base currency. - Zero-commission brokers generate revenue through premium services, margin interest, and payment for order flow. - Payment for order flow creates a conflict of interest and can impact trade execution quality. - These platforms often lack advanced features like research reports and trading charts found in traditional brokers. - Zero-commission brokers have expanded market access to smaller investors by lowering cost barriers. - Investors should be aware of the risks and costs despite the allure of free trading. - Limit orders can avoid bid-ask spread costs but carry the risk of unfilled trades. - The platforms use design features to keep users engaged, sometimes encouraging frequent trading. ## Chapters 1. 00:00 Introduction and Sponsor Message 2. 00:58 Why Zero Commission Brokers Aren't Really Free 3. 01:56 Overview of Brokerage and Zero Commission Concept 4. 03:49 Impact of Zero Commission Brokers on the Industry 5. 04:51 Bid-Ask Spread Explained as Hidden Trading Cost 6. 05:42 Bid-Ask Spread Impact on Options and Less Liquid Stocks 7. 06:37 How Zero Commission Brokers Make Money 8. 07:32 Foreign Exchange Fees as a Hidden Cost 9. 08:29 Conflicts of Interest from Payment for Order Flow 10. 09:26 User Engagement and Behavioral Design in Trading Apps Answers ## Questions about this video What are the hidden costs of zero-commission brokers? Hidden costs include the bid-ask spread, foreign exchange fees, payment for order flow, and fees from premium services or margin accounts. How does the bid-ask spread affect my trades on zero-commission platforms? The bid-ask spread means you buy at a slightly higher price and sell at a slightly lower price than the market price, effectively paying a fee on every trade. Why do zero-commission brokers still make money if they don't charge trading commissions? They earn revenue through payment for order flow, premium account fees, margin interest, and foreign exchange fees, among other methods. ## Full Transcript โ€” Download SRT & Markdown 00:00 Speaker A This video is sponsored by NOAA, an app I use to listen to articles from the world's leading financial publications. Visit the link to the News Over Audio website in the description below to get unlimited access for a week plus 37% off the annual membership fee. 00:14 Speaker A There's a lot to be said about free stuff. The best things in life are free. Coco Chanel. I don't care how much money you have, free stuff is always a good thing. Queen Latifah. Being on TV has changed my life because 00:26 Speaker A I get lots of free stuff. Kim Kardashian. Clearly, people like free, which is why, with the recent innovation of the zero commission broker, we've seen a lot of people migrate their capital to these platforms, and for good reason. These services, which 00:42 Speaker A include Robinhood in the U.S. and Wealthsimple Trade here in Canada, allow amateur investors to buy and sell stocks as well as other securities with no commissions. Compared to traditional brokers that might charge twenty dollars a trade, it's a pretty 00:58 Speaker A attractive feature. But the thing is, these platforms aren't really free. True, they can save you a lot of money, and they are very handy services to have access to, but there are four ways these services still cost you, and yes, this does include 01:13 Speaker A actual fees that come out of your account balance. So let's explain why, in the world of investing, there's no such thing as a free lunch. On today's Plain Bagel, before we get into today's topic, I want to be clear that despite the drawbacks 01:28 Speaker A we're going to discuss, zero commission brokers do offer a lot of benefits to investors. The less you pay to get your money invested, the better. And in truth, zero commission brokers have greatly expanded the accessibility of investing to those with smaller account balances 01:44 Speaker A who may not be able to afford a fixed dollar commission every time they put some of their paycheck into the stock market. I think that's incredibly important. It's also worth mentioning that some of these four costs apply to 01:56 Speaker A all types of brokerages, not just those with zero commissions, and some zero commission platforms only do have a few of these costs. That all being said, I think we can all agree it's still important to understand where you 02:08 Speaker A might be losing some money with these platforms and how they actually present new challenges when compared to the traditional broker, as you'll see from point four. But before we get into all that, let's start by explaining what exactly a 02:21 Speaker A zero commission broker is. You can certainly skip this part with the timestamp in the description below if you are already aware of all this information. As you may know, a broker is someone who buys and sells stocks and other securities on a client's 02:34 Speaker A behalf, whereas you can buy a mutual fund directly from a fund company or a GIC directly from a bank. Stocks and ETFs can only be purchased on exchanges, a sort of exclusive marketplace where members trade securities. Brokers provide 02:49 Speaker A investors access to this marketplace and find buyers and sellers for client orders. In return, investors would traditionally pay a commission to the broker per trade, something like 20 dollars an order. While this might not seem like a lot of money, 03:04 Speaker A it does make buying and selling individual securities pretty expensive for beginners. If you were hoping to invest 100 dollars a month of your paycheck into the market, you'd be losing 20 dollars of your capital right from the get-go each trade. 03:18 Speaker A These days, however, zero commission brokers allow you to buy and sell on exchanges without that mentioned trading commission, something that has had a pretty big impact on the finance industry. In fact, while the first zero commission brokers were primarily 03:33 Speaker A startups like Robinhood, we've since seen incumbent institutions like Charles Schwab and TD Ameritrade more or less forced to waive their own trading commissions to stay competitive, highlighting a pretty encouraging trend in the industry for everyday investors. So you can see why the zero commission 03:51 Speaker A broker has become pretty revered among investors. True, they often lack some of the features of more expensive brokers like research reports or trading charts, but you can't argue with free, right? Well, funny enough, even though you don't pay commissions with these brokers, 04:07 Speaker A you do still technically pay a trading fee when you buy or sell, and that's all thanks to something known as the bid-ask spread, which is the first of our four costs today. You may have noticed that whenever 04:20 Speaker A you buy a stock on your brokerage account, you immediately have a very small loss on the position. This is because you don't actually buy or sell at a stock's market price but rather at what are known as the bid 04:32 Speaker A and ask prices. These prices represent what people on the market are actually paying and offering for a given stock. The bid is what the market will buy a share for, and the ask is what you must pay for the 04:44 Speaker A stock. Unfortunately, there's a spread between these two prices, with the bid price always being lower than the ask price. In other words, you always have to pay more, and you'll always get back less when dealing with securities. This spread 04:59 Speaker A is effectively a transaction fee that you pay when you trade, and yes, there is actually a financial institution at the other end of it making a profit from the spread at your expense. Fortunately, for more liquid and large-cap positions, the 05:14 Speaker A spread is pretty negligible at just a few pennies per share when it comes to companies like Apple or Google. But as you venture into smaller-cap positions, the fee can equate to as much as half a percentage point on your capital 05:27 Speaker A or higher. Still worse yet is if you deal with derivatives such as options. Last I checked, an at-the-money call option on Apple shares had a spread representing 1.7 percent of the option premium, and the further away the strike price 05:42 Speaker A deviates from the current stock price, the less liquid the option and the wider the bid-ask spread becomes. It's not uncommon to find spreads equating to a double-digit cost on the premium that you're investing your money into. Now importantly, this is something all 05:59 Speaker A brokers have to deal with. Unfortunately, you can technically avoid paying the fee by submitting what's called a limit order, where you specify the price you'd like to buy or sell at. The only problem in doing so is that you 06:12 Speaker A run the risk of not actually having your order fulfilled. The ask price will still have to drop to hit your limit price for the order to execute, so if the security actually moves in the other direction away from the price you've indicated, 06:24 Speaker A you'll be left without the position. Now the second and third costs of the zero commission broker have more to do with how these services actually make their money because, as you can probably expect, there's got to be something that's 06:37 Speaker A bringing home the bread and keeping the lights on for these firms. You may be aware that these platforms engage in a number of other practices to earn revenue since they can't charge commissions. Some of these revenue streams are pretty 06:48 Speaker A straightforward and easy to understand. Platforms often offer a premium version of their service for a regular fee, while others may provide margin accounts, a type of account where users can pay an interest fee of sorts to borrow money for the purpose of 07:03 Speaker A investing. But one fee that often goes overlooked is foreign exchange, our second cost today. If you ever buy a stock in a currency that varies from that of your account currency, chances are you'll be charged an arm and 07:16 Speaker A a leg for the forex. Here in Canada, for example, where it's often common to hold U.S. positions, Wealthsimple Trade charges 1.5 percent on U.S. dollar trades. Now you won't find this fee on Robinhood because you can't buy foreign stocks on 07:32 Speaker A the app, but I am surprised how few people actually realize they're paying an FX fee when they buy a foreign-listed company. And for the most part, I don't think these brokers do that good a job of making it known 07:44 Speaker A that this fee is being charged when you buy these sorts of positions, so it's something that often goes unnoticed. And speaking of opaque practices, we do have to address the one that landed Ro... 07:59 Speaker A is payment for order flow which today is our third cost this is the controversial practice where a broker routes their client trades to a market maker a large financial institution that trades its own inventory of shares to profit from the bid ask spread we 08:16 Speaker A mentioned earlier this in essence means the broker is letting the market maker someone who might actually take the other side of the order execute the trade for the client now while this doesn't provide an explicit cost to the investor 08:29 Speaker A the problem is that this arrangement introduces a pretty clear conflict of interest for the broker while brokers are mandated to provide the best execution price for clients there is obviously an incentive to send the orders to the market makers 08:43 Speaker A paying the highest prices in other words brokers may be incentivized to place your order at a worse price in order to receive more money themselves in the past we have actually seen this practice lead to larger bid ask 08:56 Speaker A spreads in certain areas now it is worth mentioning that payment for order flow can technically benefit clients by a letting the broker earn money elsewhere so they can avoid charging those commissions and b leading to a possibly better 09:11 Speaker A execution price by letting a specialist market maker fulfill the order with their expertise in economies of scale but payment for order flow is actually outlawed here in canada and a number of other countries and there's been a rising concern in the us 09:26 Speaker A that those market makers can abuse the information from this arrangement robin hood was largely criticized after it froze trading for gamestop amid the stock's massive short squeeze because as it turned out they were receiving payments from citadel a market maker with a short 09:42 Speaker A position against the company so while may not see a fee on your account statement from this practice it's not unthinkable that it could lead to a worse execution price at your expense finally while the costs we've covered have been a bit more 09:56 Speaker A literal the final one is a bit less explicit but i truly believe it's just as important as the others and that's the incentivization to trade i think we can all agree that between paying fees and not paying fees we'd all opt for the latter 10:12 Speaker A but many of these platforms have made trading almost too easy stocks and even more complicated derivatives like options can now be bought and sold with the top of the button on your smartphone making it very easy to give in to 10:25 Speaker A trading impulses in many ways this is by design just like how facebook is programmed to keep users scrolling through their feed these brokers have incorporated many features to keep you interested in the markets including the addition of social 10:39 Speaker A networking features and phone notifications because at the end of the day they make money the more you trade some have even accused these platforms of gamifying the investment experience it's only recently that robin hood removed the confetti animation you got 10:53 Speaker A from buying your first position on their platform combine alluring features on a smartphone app with our natural inability to rationally manage money and you end up with a lot of people trying to day trade rather than focusing on long-term buy and hold strategies 11:09 Speaker A this might not seem all that dangerous but research paper after research paper has suggested not only that more trades equal lower returns but also that the majority of day traders actually lose money now certainly people are free to do as they please 11:25 Speaker A and as some people like to point out the public is becoming more informed on the risks of investing meaning they should be able to participate as they please in the markets but the problem is that these platforms seem to actively be targeting 11:38 Speaker A inexperienced investors with this sort of practice well wealthsimpletrade recently hired tick-tockers to talk about how easy it is to buy individual stocks and crypto on their platform chances are this isn't trying to persuade the educated stock picker who knows what they're doing 11:53 Speaker A and here's the thing i'm truly not against diy investing or using zero commission brokers even with these four highlighted costs i honestly believe these platforms have helped a lot of people get started with investing which is such an important practice for 12:06 Speaker A enhancing their financial well-being but the problem is that we've seen a rise of retail investors partaking in riskier and riskier strategies much to their own detriment i think these platforms have played a big role in that so if you want to use these services by 12:19 Speaker A all means but i do believe you need to be disciplined using them at the end of the day they are financial institutions trying to make money not charities and chances are there are some inexperienced investors who have lost money 12:31 Speaker A directly because of how these platforms operate and market themselves that's not to say you can't or even that you shouldn't take advantage of their offering just don't let the offering take advantage of you it'll cost you more than you might expect 12:44 Speaker A when it comes to diy investing being properly educated is a must part of this is learning accounting rules and economic fundamentals and the other part is staying current on the markets there are a number of ways to do this but today's sponsor noah 12:56 Speaker A offers a pretty cool service to help in that arena noaa is an audio app that allows you to listen to thought-provoking journalism that you don't have time to read they professionally narrate articles from publishers like bloomberg the economist and harvard business review 13:09 Speaker A excellent news sources that often require a subscription to access anyway for example i recently listened to why are stock brokers allowing you to trade for free a series of articles noah curated on today's video topic and that's another great thing about the 13:22 Speaker A app noah uses a team of experts to link articles together so you can get multiple perspectives on a given topic i personally really enjoy the app i use it almost every time i go for a walk it's a nice way to rest my eyes while 13:34 Speaker A still learning something new and if it sounds like something you'd be interested in checking out you're in luck because the first 100 people to visit newsoveraudio.com or use coupon code plain bagel will get one week of unlimited access for free 13:46 Speaker A plus 37 off the annual membership fee it's a great service full of great information so check them out you Topics: zero commission brokers Robinhood Wealthsimple Trade bid-ask spread payment for order flow foreign exchange fees investing costs 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