The Discount Brokerage Revolution

Hello fellow personal finance readers. I go by the pen name “Teacher Man” due to the fact that I recently graduated from university and am in my second year of teaching high school. About 9 months ago my partner and I started a website called My University Money. It is aimed at helping young people (with a specific focus on post-secondary students) and just talking about financial and student lifestyle issues in general. Young & Thrifty was one of the first bloggers to really reach out to us and give us a little recognition when we were just starting off. When I read that Y & T was hitting a busy patch in life I offered to do a little staff writing for her, and she graciously accepted. Many in the investing industry have been singing the praises of the explosion in discount brokerages over the past couple of decades. The fact is that online discount brokerages which cut fees to the bone (as little as $5 per trade) have completely changed the way the investing game is played. It wasn’t so long ago that someone wanting to invest had to ring up their full service stock broker (on a rotary phone) and ask them to place their trade for an exorbitant fee (often $50-$100). Unless you were one of the big fish, your order got put on the back burner until whenever your broker got around to it. These days investors have access to real-time quotes, and a bevy of current information that even corporate investors couldn’t have dreamed of 30 years ago. This is great news for the little guy right? Uh… the jury is still out on that one.

So You Think You Can Trade?

Stock Market Pictures, Images and Photos

There is no doubt that the internet and the way it levelled the information playing field (kind of), as well as its pricing structure is to most peoples’ benefit IF they practice the same investment strategies as before. Therein lies the major problem. In the past, investors looked to make sizeable investments in companies they believed had a competitive advantage and would consequently do well over time. Paying these large fees to move in and out of investment positions was a major incentive to practice buy-and-hold investing. Today, you can turn on your TV to anyone of 3-5 channels that will be spinning some sort of voodoo about the latest earnings reports, or some new cookie-cutter shaped technical analysis theory, and that makes a lot of people believe that they could be the next Goldman Sachs hedge fund manager if they watch enough of the garbage. When you combine this with the sudden ability to trade whenever, and however you want, for a cheap fee, you can do a lot more harm than good.

Trading With The Stars

Investing is not trading. People often get this confused. When people watch Wall Street movies and get caught up in the adrenaline rush (admittedly, we testosterone-driven types are most susceptible to this) of getting rich quick, they get a ridiculous view of what investing should truly be about. It seems to me that a lot of people have forgotten that the whole point of the stock market is to allocate capital to the best companies. It is the natural extension of free market ideas that the companies that have proven they can do the best with what they have (and produce something valuable) should get more money to work with, and should see their value continue to grow. Online discount brokers have greatly aided this trend where we have moved away from that ideal, into this crazy casino world where people try to make money from nothing by attempting to predict the irrationality of the markets on a minute-by-minute basis. I want to yell at these people that Wall Street has mathematical geniuses working for them that have invented automatic algorithms that are powered by state-of-the-art technology and insider information. Do you really think you can beat these guys at their own game staring at charts? People on my site are probably sick of hearing about my worship of Warren Buffett and his patient, value investing ways, but I always think that this guy is the pinnacle of what true investing should be about – not day traders looking to cash in on some made-up “momentum swing.”

The Cheap Trade Factor

Is the invention of the $5 trade a bad thing? Not if you are realistic about the markets and your strategy within them. I’m by no means a stock guru, but pretty much every single investment study out there will back me up when I say that any sort of diversified, buy-and-hold strategy will work much better than trying to ride the latest trend. It doesn’t matter if you’re a dividend investing apostle, an ETF/Index investing convert, or a value investing Buffett-ite, you will be better off than the guy who trying match wits against the sharks on Wall Street. The $5 trade has saved smart investors a ton of money. It has also majorly cut into the slim profit margins that most investors have seen over the last few years. Go ahead and look for yourself at the studies done over the past 20 years comparing active traders to people who index is boring old index funds once every month. There is an old saying in poker that if you can’t pick out the sucker in the first hour, than you’re the sucker. How do you think these hedge fund guys can make such outrageous returns? Someone has to be at the other end of them, and I know it’s not the guy sticking his money in ETFs and Index funds.

Are You Smarter Than A Hedge Fund Manager?

For years economics professors out there loved to talk about how they had come up with a magical formula for the stock market called the efficient market theory. This approach basically claimed that since everyone now had access to such good information, supply-and-demand fundamentals guaranteed that every stock was appropriately priced at any given moment. This may have had some degree of validity when people carefully considered their investments since it cost $100 a pop to buy or sell any shares at all.  I’m fairly certain that in today’s headline-driven markets it holds almost no short-term relevance at all. We are seeing more volatile markets now than ever before, and there is little doubt that this is influenced by the competition over who can produce the most extreme headline, and the ability of the do-it-yourself investor to rush to their computer and “join the heard” trying to follow whatever the latest “Mad Money” tip was . Humans have always been genetically hardwired to be bad at investing. Our risk-averse nature basically guarantees that most of us will want to buy high and sell low the majority of the time. With trades so cheap and access to accounts so easy these days, those millennia-old instincts have an instant outlet, and this is not good for many investors.

Be a Wall Street Survivor

Don’t be one of these investors that plays right into the hands of the investment industry. Even though fees are lower, investment brokerage employees are still driving yachts (albeit maybe slightly smaller ones now). When you use low-cost trading to justify a hyperactive, instinct-driven investing style, your just eating into your meagre returns (which now can’t compound over time) and buying some rich dude a new Mercedes (regardless of how you do on the actual trade). Instead, take advantage of this competitive new market and save yourself a ton of investing fees over your lifetime.

About

Young is a writer and former owner of Young and Thrifty and the main "twitter' behind Young and Thrifty's twitter account. She lives in Vancouver, BC and enjoys long walks on the beach, spending time with her anxious dog, and finding good deals. If you like what you read, consider signing up for email updates.

16 Responses to The Discount Brokerage Revolution

  1. I agree – the voodoo on TV, with all the talking heads clamoring over this stock or that stock, combined with the cheapness of trading, does most people more harm than good. The more turnover you have in your portfolio, the worse your odds of keeping pace with the overall index. In the world of investing, simpler is better.

    • @Paula- Yup! You couldn’t have said it better! There’s too much “white noise” that easily manipulates us into “acting” on our impulses and selling when the market is down. The cheapness of discount brokerages doesn’t help one bit!

  2. This article is excellent!!

    I especially like this: “Investing is not trading. People often get this confused. When people watch Wall Street movies and get caught up in the adrenaline rush… of getting rich quick, they get a ridiculous view of what investing should truly be about.”

    I often meet people, especially at work, who think that trading is investing. When I explain to them no it’s not, that I buy Index Funds and Dividend Paying Stocks for the long term. They stare at me with that completely blank look – they have no idea what I am talking about >@@<. This makes me sad, becuase it means that most people are not investing – they probably hold mutual funds.

    Great Post MUM and I will include this in my Weekly Newsletter Lineup!

    Cheers
    The Dividend Ninja

    • @TDN- Isn’t it? Teacher Man is awesome! He has a way with words and can make anything sound eloquent!!!

      Many people think trading is a fast way to “make a quick buck” but it isn’t unfortunately!

  3. Great article YT! I agree with you that the markets appear to anything but efficient these days and I think you are spot on in your reasoning as to why this is. It probably isn’t the whole story, but definitely part of it.

    I personally like the fact that the markets aren’t efficient as it allows you to take advantage of good buying opportunities when the herd gets panicked.

    I have to say all the computer trading that goes on these days scares me too. It always makes me have this sinking feeling that somehow I’m getting screwed by a computer when I’m making a trade – haha!

  4. Nice post! I too, liked the “Investing is not trading.”

    Absolutely.

    The stock market is not a casino, it is a market, you go to buy good and services just like many other types of markets. Sometimes you find great products, other times, not so much. Buyer beware.

    Will tweet and include in my Weekend Reading later tonight! :)

  5. You make some seriously good points here. Even full time investment analysts usually can’t beat the market consistently. I am a fan of using that $9 trade fee to buy a solid ETF or Index fund for the long haul.

  6. @ TDN – Thank you sir, I really appreciate the compliment coming from a great blogger!

    @Saving Mentor – You probably are being screwed if you’re trying to trade and not trying to invest. I always think that investing is a net positive game. In other words the pie being divided is always getting bigger. You can take advantage of that by investing. Trading is a net negative game, because due to fees, the pie is always smaller. Can the vast majority grab a big piece of that shrinking pie when competing against math geniuses armed with super computers? Well… some guys have gotten rich at roulette right?

    @MOA – I think everyone should be required to read Buffett’s approach to investing before putting money in the stock market. It’s hilarious how much he distrusts all these “Wall-Street types” and investment banking guys.

  7. The problems are not typically the $5 trading fee. Sure technology has opened up the markets to significantly more people but the reality is before discount brokerages, people were being taken for a ride just as much as they are today only perhaps for bigger dollars.

    Regardless of the type of investing (mutual funds, ETFs, stocks, bonds, etc) the biggest problem people have is the lack of a strategy to help them achieve a plan (which they probably don’t have either). You are absolutely right in saying that trading is not investing. However trading can certainly be a part of investing if it has the right parameters around it. What do most people want? They want their investments to be worth more tomorrow than they are today. If that wasn’t the case, nobody would put money away. But how do they accomplish this task? Perhaps they should begin with goal setting and then create an investing strategy that works within their risk profile. For example, there isn’t anything wrong with saying you would buy a good quality stock (read TSX 60 blue chip dividend paying stock) that most of the time falls within a trading range. A good example might be Suncor or Bank of Nova Scotia but there are many others. If you understand the markets and analyze a handful of companies that you feel right to invest in, you can certainly take small profits off the table as the stock moves through its cycles. And a bonus is the dividend that you can get. But here’s the thing, if your good blue chip stock can go from $40 to $50 but your dividend is only $2 per share, why would you not take your money off the table and wait for that opportunity to repeat itself.

    There isn’t any particular reason to stick with just one strategy and ignore other areas of investing that could safely and responsibly create a better return if combined together. Sure dividend investing is great as long as you don’t need to sell your shares when they are significantly lower (like 2008). Sure index investing is great but what happened to the index since the April highs? Why watch that happen to your portfolio?

    The way people can implement a good plan and a good strategy is getting educated. That education should include understanding what is happening in the world, what is happening within the markets as a result of what is happening in the world, how to identify and work with good companies (and not 20 of them), how to assess and manage risk and most importanly, how to preserve capital.

    Forget all those “experts” that think they know something. Most of them are paid to create content or garner an audience. Your money should be a priority to you and your family. When you take it seriously (and most day traders have no idea what that means) you will find a method that works well for you.

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