Major online brokerage TD Ameritrade (NASDAQ:AMTD) announced that it would follow rivals Fidelity and Charles Schwab (NYSE:SCHW) in slashing commissions for online stock and ETF trades, effectively becoming the latest participant in a discount brokerage price war. This is welcome news for all investors who use these brokers, but it could be particularly helpful for newer, smaller investors.
Competition is heating up, and prices are falling
In the past week or so, competition has intensified among online brokers to offer the best combination of value and service to investors. First, Fidelity Investments announced that it was slashing its stock and ETF trading commissions from $7.95 to $4.95.
Just a few hours after that announcement, rival Charles Schwab matched that $4.95 price. This represents Schwab's second such price cut in a month, as the price was already lowered from $8.95 to $6.95 earlier in February. Later the same day, TD Ameritrade announced that its per-trade price would drop from $9.99 to $6.95. Similar cuts were also announced for options trading from the brokers.
Now, it's important to note that price isn't everything when comparing brokers. As I've written recently, the features each broker offers also need to be considered. Some offer excellent trading software, educational resources, and access to top-notch stock research reports. In full disclosure, I use TD Ameritrade because I find its platform to be feature-packed and user-friendly, and love their research and other resources.
As I write this, these are the only three major brokerages that have lowered their prices, but I wouldn't be surprised if others, such as E*Trade ($9.99 commissions), decide to follow suit.
What it means to you as an investor
Loan comparison website LendingTree's slogan is "When banks compete, you win." The idea is that when banks are actively competing for your business, prices will naturally come down. Similarly, when brokers compete, investors win.
I've written before how it's not practical to create a well-diversified portfolio of stocks without having a few thousand dollars to invest, and that people who don't are better off starting with mutual funds or commission-free ETFs. And I continue to stand by that statement. After all, the minimum number of stocks I'd suggest for a diversified portfolio is five or six, and if you only have say, $500 to invest, you can easily end up spending 10% or more of your money on commissions.
However, these new price cuts have lowered the threshold to where investing in individual stocks becomes practical to smaller investors.
I'll share a bit of my personal investment strategy to illustrate this. As I mentioned, I use TD Ameritrade, which is not the cheapest broker, but I love their platform and resources, so I'm willing to pay a few dollars more. As a rule, I like to keep my commissions to less than 1% of any investments. In other words, at TD Ameritrade's $9.99 commission, this means I need to buy at least $1,000 of a stock to justify the transaction. So, I need to wait until I've accumulated $1,000 of spare cash before I can put it to work.
Well, at the revised $6.95 pricing, this reduces my threshold to just $700. Now I can buy stocks more frequently without commissions eating more of my investment returns before I even produce any. Or, I can choose to keep the same $1,000 threshold and enjoy a 30% lower commission expense.
The Foolish bottom line
This "1% commission rule" I just discussed is simply my personal preference, but it does illustrate the accessibility that these price cuts bring to smaller investors who are investing hundreds, not hundreds of thousands, of dollars at a time. So, if you've been considering making your first stock investment, this could make it more practical to get started.