The Pitfalls Of Commission-Free Trading

The evolution of self-directed investing through discount brokerage platforms has driven the cost per trade down from $29 a decade ago to $9.99 at big bank brokerages today. Some discount brokers (like Questrade) offer free ETF purchases, and one platform – Wealthsimple Trade – even offers commission-free trading of stocks and ETFs with no account minimum.

To be clear, this democratization of stock and ETF trading is a net positive for DIY investors who can contribute to their portfolios more frequently without worrying about incurring hefty trading fees. But there’s a downside to commission-free stock trading that has been brought to light during the coronavirus pandemic. 

The Wall Street Journal reported that online brokerages are seeing record spikes in new accounts and trading activity in recent weeks. The authors argue that this trend is due in part to the industrywide move to zero-commission trading through platforms like E*Trade and Robinhood, and exacerbated by the fact that many individual investors have more time on their hands to trade as they work from home.

“Many are young and first-time traders confronting the first economic downturn of their professional lives. Yet with free trading at their fingertips and massive online communities with which to discuss trading ideas, many figure they have little to lose.”

Robinhood has amassed more than 10 million users since launching in 2015, with a median client age of 31. Nearly half of its users are first-time traders.

This article uses American data, where commission-free stock trading has been around for some time. Canada is slightly behind the times, but Wealthsimple Trade has seen a similar trend north of the border. Its clients are trading into this volatile market to a staggering degree.

This graphic shows the most traded stocks on Wealthsimple Trade this quarter. Aurora Cannabis led the way in January and February, before being overtaken by Air Canada at the end of March. 

So what is going on here? 

Obviously young investors have been drawn to the commission-free platform and they’re looking to hitch their wagon to the fortune of individual stocks that have either been hammered (Air Canada, Aurora Cannabis), or that have a compelling story (Shopify, Tesla).

But is this a new trend driven by more accessible stock trading platforms? Hardly.

For every story I’ve heard recently about investors losing their shirts trading oil ETFs, I can recall similar stories in the late 90s of investors day trading from their college dorm rooms and losing it all when the technology bubble burst. 

Speculators at that time were not dissuaded by trading commissions – not with the allure of easy profits to be made on the latest internet stock.

I hope this is a chance for investors to learn some tough lessons about investing (betting) on individual stocks in hopes of turning a quick profit. After all, the worst thing that can happen to a young investor is to have early success trading stocks. It’s not a path to riches over the long term – but just a matter of luck and being in the right place at the right time.

Why I Chose Commission-Free Trading

I invested in individual stocks for years and had some success – mostly because I started trading in 2009 when stocks began their incredible bull market run. I came to my senses in 2015 and switched to index investing, due in no small part to some of my energy stock picks getting cut in half.

Back then, at $29 a trade, I’d sensibly save up at least $3,000 before pulling the trigger on a purchase. When commissions fell to $9.99, I felt more comfortable putting $1,000 to work at a time. 

The way I see it, commission-free stock and ETF trades allow investors to put very small amounts into the market right away. And that’s a good thing. It’s what drew me to switch from TD Direct Investing to Wealthsimple Trade. Since then, I’ve bought as little as $100 worth of VEQT in my investment portfolio. 

Commission-free trades have been a great evolution in the low cost, self-directed investing journey. It’s especially great for passive investors who invest in a portfolio of ETFs. We can add small amounts to our portfolio and invest right away. We can rebalance for free by selling the ETFs that have risen in value and buying more of the ones that are lagging behind.

But I can certainly see the pitfalls of commission-free stock trading. The barrier to entry is almost zero, making it easy and affordable for new investors to start trading. That can be a dangerous experience for a novice investor.

Most of these cautionary tales are aimed at new investors, but there’s also the core-and-explore cohort who can get caught up in trading stocks – especially when it’s free to do so.

A Wealth of Common Sense blogger Ben Carlson shared his not so common sense strategy of having what he called a fun portfolio. This is where he’d allocated 5 percent of his portfolio to picking stocks to “scratch an itch to take more risk”.

Some of the lessons learned from this ‘fun portfolio’ during the market crash was checking on the performance way too often (daily), and buyer’s remorse or second guessing market timing decisions. 

These are just some of the reasons why, in the second edition of Millionaire Teacher, author Andrew Hallam removed “the 10% stock picking solution … if you really can’t help yourself” from his nine rules of wealth.

Final Thoughts

I’m all for lowering costs and making it easier for investors to trade. Sure, there are pitfalls to avoid when it comes to commission-free trading, but I’d argue that the positives outweigh the negatives in the big picture.

Trading commissions didn’t stop day-traders during the tech bubble, and didn’t stop speculators from trading distressed stocks during the great financial crisis in 2008.

Moreover, it’s unfair to paint this as a generational issue. Yes, young investors may be drawn to commission-free and mobile-only platforms like Wealthsimple Trade, but it’s not just Millennials who got burned trading cannabis stocks. Clients of mine in their 60s lost 95 percent of their non-registered investments betting on weed stocks. 

My takeaway from this data is not to avoid commission-free trading platforms but for self-directed investors to stop gambling on individual stocks and instead invest in a low cost portfolio of ETFs.