Commissions have long been the bane of investing. In the past, investors trading relatively small amounts of stock could expect to pay commissions worth several percent of their investment, and most mutual funds took up to 8.5% off the top when you made a deposit to your account. With the emergence of pioneering discount brokers such as Schwab (Nasdaq: SCHW ) , commissions started to become more reasonable for small investors.
Now, the race to the bottom has finally reached the finish line. Wells Fargo (NYSE: WFC ) has joined Bank of America (NYSE: BAC ) in planning to offer commission-free trading for their customers. Yet even though these firms won't be earning money from stock trading, their offers may still generate big profits.
What you get
Each offer gives you the opportunity to make a certain number of trades without having to pay commissions. At Bank of America, you can make up to 30 commission-free stock trades each month. Wells Fargo gives you 100 trades each year without commissions.
Having this number of free trades available allows investors to consider strategies that are otherwise too costly, even at discounted commission rates. For instance, investors could implement monthly investing programs in which they buy small numbers of shares of several different companies. To obtain a more diversified portfolio, investors could buy shares of exchange-traded funds. Even if you have only enough to buy a single share, a free commission makes it both practical and affordable. In contrast, even a low commission in the $5 to $10 range makes this strategy much too expensive.
What they get
Of course, neither of these companies would be offering free commissions on stock trades if there weren't something in it for them. Both companies require customers who want to take advantage of commission-free stock trading to have substantial banking relationships with them. Bank of America requires a minimum of $25,000 on deposit in a checking account, savings account, CD, or IRA. Wells Fargo requires the same amount, but it's somewhat more liberal about including other types of relationships to count toward the $25,000 total. For instance, the Wells Fargo program allows you to count 10% of your outstanding mortgage loan balance toward qualifying for free trades. Other products, such as credit cards and trust accounts, may also be included for qualification purposes.
Clearly, both companies hope that requiring customers to use other financial services to get the benefit of commission-free trading will prove profitable. At Bank of America, investing $25,000 in a standard money market savings account would currently only earn interest at a 1.25% rate. Some competitors offer savings accounts paying 5% interest or more. Over the course of a year, the difference would amount to nearly $1,000 of lost interest. On the other hand, some Bank of America products, such as CDs, pay interest closer to market rates. If you want to take advantage of these no-commission offers, be careful to choose savings options that won't cost you greater returns.
If you already have relationships with either of these banks, you may be able to take advantage of these offers without making any changes to your finances. Wells Fargo's decision to count mortgage loan balances toward its required limit is especially helpful. On the other hand, the offer makes it more difficult for you to change banks. If you're counting on your mortgage to qualify for free trades, you'll be less likely to refinance with another lender.
Even though saving on stock commissions is a smart move that can save you hundreds of dollars each year, you should watch out for a few things. Just because the trades are free, you don't have to use your entire allotment. Since many people want to take maximum advantage of a bargain, you may be tempted to find reasons to use all of your free transactions, even if it means trading in and out of stocks you'd ordinarily just hold. Having free trades may make it easier to add smaller amounts of money to your existing portfolio, but if your overall investing strategy has been successful, don't change it just to use up your free trades.
Also, if you choose to participate in one of these programs, keep your eyes peeled for any future changes in terms and conditions. True, the discount brokerage industry is so competitive that using bait-and-switch tactics to lure customers would probably backfire. Still, there's no guarantee that you'll be able to enjoy free trading forever. Given the many fees often involved in transferring assets from one brokerage firm to another, you don't want to have to move your investments very often.
As the trend in commission pricing moves toward zero, astute investors can benefit from competition among discount brokerage firms. By keeping a critical eye toward on a particular broker's motives in lowering its commissions, you can be sure to make the decision that's best for your overall finances -- not just your trading costs.
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Fool contributor Dan Caplinger still pays a buck or two for most of his stock trades. He doesn't own shares of the companies mentioned in this article. Schwab is a Motley Fool Stock Advisor pick, while Bank of America got the nod from Motley Fool Income Investor. The Fool's disclosure policy is part of our bargain with you.