When Are Free Stock Trades Not Free?

[Updated on October 3, 2007. Zecco requires $2,500 minimum after Jan. 1, 2008. Added links to related posts.]

Zecco and WellsTrade (a subsidiary of Wells Fargo) offer commission-free trades. Zecco requires no $2,500 minimum balance. Only stock and ETF trades are free. Mutual fund trades are not free. Wells Fargo’s PMA Package requires $25,000 minimum which isn’t too hard to qualify. Its free trade offer includes mutual fund trades too.

Free is good, right? To the extent you are going to make the same exact trades, yes, free beats not free. But have you bought on impulse stuff you don’t really need simply because it was a good deal? I have, many times. The stuff I bought ended up being a waste. I just collected more junk. I can see I’m not alone. Same thing may happen when the trades are free. Speculation is human nature. We want to prove we are right. Not having a transaction cost makes the urge for speculation stronger. Trading simply because of free trades is not a good idea.

A good usage of free trades is dollar cost averaging into ETFs. A disadvantage for ETFs has been that buying an ETF requires paying a brokerage commission. Free trades eliminate that. That’s great. If the trades are not free, people will probably select the broadly diversified ETFs like Vanguard Total Stock Market ETF (VTI), Vanguard FTSE All-World ex-US ETF (VEU), and Vanguard Total Bond Market ETF (BND). A combination of a few broadly diversified ETFs pretty much cover everything. When the trades become free, one may be tempted to invest in niche segment ETFs like biotech, mining, gold, international real estate, or whatever is in fashion lately on Wall Street. That’s not good. 

A bad usage of free trades is speculating on stocks. A relative of mine is doing just that. He opened a Zecco account with $2,500 for trading stocks using chart reading aka technical analysis. He’s usually a very frugal person. He always seeks out the best deal whenever he buys anything. This time he also got himself the “best” deal – ”Hey the trades are free!” The trading commission may be free but he still has to risk real money for the trades. It’s really a bad idea. Experimenting with stock picking can lead to two outcomes:

  • The picks worked. He becomes excited in his picks and allocates more dollars to his experiment. Now we are talking about serious dollars. Then it may stop working and he just lost of bunch of money. Casino gambling usually works this way. You win a little, gamble more, then lose it all.
  • His picks didn’t work. The money he loses is way more than the commission he supposedly saved.

If there were no free trades, I don’t think my relative would’ve started his experiment because he can see how paying $5 a trade on an average trade size of $200 is not going to be very profitable.

For now, until I can convince myself I won’t ever be sucked into mindless trades, I’m sticking with my brokerage account where trades are not free. Having to pay a commission at least makes me think twice before I place a trade. I’m not sure I’ll be able to resist the impulse trades if they are “free.” Because I believe in simplifying finances, I have very little interest in spreading my money in 10 different accounts or moving my accounts around all the time chasing after the loss leading deals of the year. $11 a trade is good enough for me if it holds me back from doing something stupid.

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