For long-term investors, $0 commissions for online trades can be a double-edged sword. Cheaper trading can make it easier to diversify, but it can also be an extra reason to be cautious.
One of the hardest things to do as a long-term investor may be maintaining your composure and sticking to your portfolio strategy when big news is moving the market against your positions.
In your head, you know that these bumps tend to even out over time, but in your gut, you may have plenty of butterflies. Before online brokerages began to do away with commissions for online trades, that extra cost per trade could act as a mental check to help you stay the course and not end up missing out on long-term market gains.
But with online trading commissions going the way of the dinosaurs, now seems like a good time for an extra reminder to stick with the portfolio construction strategy you’ve worked out based on your own goals, perhaps with a financial professional.
Of course, zero-commission trading can be a good thing. Not having to pay that extra money per trade makes it cheaper to set up a portfolio and trade within it. It means you have more choices for self-directed diversification, especially if you’re just starting out as an investor. If you want to build up a portfolio of 20 or 30 diversified stocks, that’s now less expensive to do.
The removal of that barrier could tempt you to diversify more than you might if you were spending money to place every trade. If you’re thinking, for example, of adding exposure to the Utilities sector as a short-term defensive move, you no longer need to weigh the transaction costs against your expected benefit from the trades.
Within a diversified portfolio, incremental changes such as taking profits or shifting winners and losers will no longer incur commissions. You don’t have to think about whether you’re going to make enough on the trade to pay for transaction costs. (This assumes, of course, that you’re only making trades that qualify for zero commissions. Some products and asset classes still carry transaction costs.)
For TD Ameritrade clients, the zero-commission trading schedule covers online trades of U.S. exchange listed stocks, exchange-traded funds (ETFs), and options trades (note: options still have a contract fee of $0.65, but there are no assignment or exercise fees).
All that sounds pretty good, and it is. But on the flip side, now it can be easier to make mistakes.
Think of commission-free trading like riding a bicycle without training wheels for the first time. There’s a risk that you might overdiversify—yes, there is such a thing as overdiversification—and add too many stocks to your portfolio when you really might just want to own fewer assets and call it a day. You might be tempted to buy into weakness or take profits too often or at the wrong times—mistakes that commissions might have made you think twice about.
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The lack of commissions makes it easier for some investors to trade emotionally when something’s happening in the markets. Without commissions, there can be a higher inclination to sell in the short run because you’re human and are now a little more free to respond to those fight-or-flight butterflies.
But just because executing a trade is cheaper doesn’t mean it’s necessarily the right thing to do. What if there were no fees for trading on margin? Would you shift to a leveraged portfolio? If such a trading style doesn’t align with your objectives and risk tolerance, a lowered fee structure isn’t a great reason to engage.
Just because you don’t have to pay commissions anymore doesn’t mean you should automatically change your investing strategy. Basically, if what you were already doing worked in a commission environment, then it should work better in a noncommission world.
Make sure your investing objectives are clear and then build a long-term allocation strategy to meet those objectives, regardless of what’s happening with commissions.
This is where investment guidance might come in handy. Managed portfolios such as those offered by TD Ameritrade Investment Management, LLC, or a financial advisor, might become even more important now that the buffer of commissions has been removed for many online trades.
A strategy that includes a financial professional or a managed portfolio might help free you from the noise and keep you focused on the big picture—your financial goals.
Matt Whittaker is not a representative of TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the author and may not be reflective of those held by TD Ameritrade, Inc.
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