Charles Schwab (NASDAQ:SCHW) is lowering its commission charges for online trades of stocks or non-Schwab ETFs. Instead of the $12.95-per-trade rate it charged smaller investors (including most of us), it'll now collect just $8.95. If the prospect of cheaper trades sounds exciting, don't get too happy just yet.

If you're a Schwab customer, or now think you might want to be, ask yourself how often you really trade. In the past few years, I don't think I've made more than a dozen trades in a year. If my commission cost per trade were cut from $13 to $9, I'd save $48 at most. And since the brokerage I use charges $10 per trade, switching would actually save me no more than $12. Low commissions are only an important part of a brokerage's offerings if you tend to trade frequently.

Ravages of war
The effects of Schwab's price cut will likely spread through the entire online brokerage industry. Schwab's competitors, such as TD AMERITRADE (NASDAQ:AMTD), E*TRADE (NASDAQ:ETFC), and Scottrade, may now consider either lowering their own rates in response, or feel pressure if Schwab's cuts narrow the gap between its prices and their own lower rates.

The online brokerage business was already more tenuous than most, even without the threat of a price war. Because brokerages haven't been able to establish a valuable competitive advantage, it's relatively easy for new competitors to enter the scene, as the fairly recent emergence of companies like Interactive Brokers (NASDAQ:IBKR) demonstrates.

In addition, any brokerage that slashes its rates will likely see lower revenue and profits. Even Schwab is estimating that it might lose up to $20 million in first-quarter earnings. If you invest in any of these companies, keep that impending hit in mind.

The more you trade, the less you make
Beyond competitive concerns, I'm worried that Schwab may be lowering commissions in part to entice you to trade more frequently. If you fall for that lure, you could rack up frequent commission costs, pay higher taxes on short-term capital gains, and generally lose out on a bigger chunk of the value you'd otherwise gain from a winning stock.

To demonstrate, I've rounded up a list of companies and their three-month and one-year gains. Check out the approximate difference between paying 15% for a long-term gain (if you'd held them for more than a year) and the range of higher tax rates that apply to short-term gains (if you'd held them for a year or less).

Held for three months:

Company

3-Month Gain

Gross Profit on $10,000 Investment

25%-35% Short-Term CG Tax

Net Profit

Amazon.com (NASDAQ:AMZN)

40.2%

$4,020

$1,005 - $1,407

$2,613 - $3,015

Hess (NYSE:HES)

16.8%

$1,680

$420 - $588

$1,092 - $1,260

Deere (NYSE:DE)

34.3%

$3,430

$858 - $1,201

$2,229 - $2,572

Held for one year:

Company

1-Year Gain

Gross Profit on $10,000 Investment

15% Long-Term CG Tax

Net Profit

Amazon.com

133.6%

$13,360

$2,010

$11,350

Hess

13.5%

$1,350

$203

$1,147

Deere

30.0%

$3,000

$450

$2,550

Data: Morningstar. Assumes taxpayer in ordinary tax bracket of 25% or greater.

In many cases, the longer you hang on to healthy and growing companies, the more you'll make. With Amazon.com above, you would have made more than three times the profit with the longer holding period, but paid less than twice as much in taxes. (With Deere, to be fair, you'd have made more profit in the short run, but in some cases netted less because of the higher tax rate.)

The big picture
Don't take lower commissions as an invitation to trade, or assume they'll be a ticket to higher profits. In the airlines and other industries, price wars often only hurt the companies involved. But in the brokerage world, a race to the bottom can leave customers feeling the pain as well.

What do you think of the Schwab price cut? Sound off in the comment box below!

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