Motley Fool Answers' September Mailbag: Which Is the Better Benefit -- Tax-Free Growth or Commission-Free Trading?

Ah, the traditional pleasures of September. Summer's heat starts to fade. Pumpkin-spice-flavored everything begins to appear on menus. People get in their first complaints of the year at seeing retailers roll out the Christmas marketing before they've even picked out their Halloween costumes. And, of course, the month would not be complete without a mailbag show from Motley Fool Answers hosts Alison Southwick and Robert Brokamp. To help them address all your autumnal financial conundrums, Sean Gates, a financial planner with Motley Fool Wealth Management, returns to the studio. 

In this segment, it's a question of which tool is better for investing with. The listener has a Roth IRA, which offers tax-free growth, and a Robinhood account, which gives him commission-free trades. He's pretty sure that the value of the former is greater than the value of the latter. The Fools weigh in.

A full transcript follows the video.

This video was recorded on Sept 25, 2018.

Alison Southwick: The next question [and it's our last question] comes from @DTShelt. "I have been having a hard time justifying my use of Robinhood over buying stocks in my Roth IRA, especially with The Fool ideology of buying and holding for the long term. Is there a place for Robinhood if I have an IRA? Stocks!" That always makes me laugh.

Sean Gates: Bonds!

Southwick: I just love when people yell stocks at me.

Gates: I picked this question because I'm not sure whether the question is if Robinhood is available inside an IRA, because I don't think it is.

Robert Brokamp: It's not.

Gates: I think it's only available for taxable brokerage accounts. But if that's the underlying question, there are alternatives to Robinhood where you could get commission-free IRA investments.

Brokamp: Which is what's attractive about Robinhood. That fact is that you do not pay commissions on the trade.

Gates: Exactly. And so there are alternatives. We could spend a little while going through that. Or alternatives that are very low cost, so maybe you pay a dollar per trade.

If the underlying question is whether there is a place to save both to the Roth and to a taxable brokerage account where I utilize Robinhood, I think the answer is clearly yes. I mean, it's going to depend on your ability to have the income and save that income, but I certainly would prioritize saving to the Roth first and then if you have extra money coming in, save it in a taxable brokerage account.

Brokamp: I would say the tax-free growth of Roth is very powerful, and it's not worth giving up just to have free commissions, because there are too many other places to pay very low commissions or no commissions. Definitely go with the Roth, first. And the great thing about the Roth IRA is that if you need the money before you're 59 and a half, you have more flexibility with getting it out early if you need it; especially just the contributions. I would definitely say max out the Roth IRA first. You're going to have to do it somewhere other than Robinhood. Then turn to Robinhood if you want those commission-free trades.

One of the ways Robinhood is able to have commission-free trades is that like a lot of brokerages, they don't pay you much on cash. [They're not paying any interest] on all the cash that's sitting in those accounts, so they can make a little money off of it. That's one way that you actually are paying some money to be part of Robinhood if you have a lot of money in cash and you're not doing anything with it.

Gates: They also sell the order flow, which is a little bit more complicated. All the brokerage firms could, in theory, have what essentially amounts to front-running trades. Let's say you want to buy a hundred shares of Apple. When you place that order, they can pause that order and then go to high-frequency traders and say, "Hey, look, high-frequency traders, this person wants to buy a hundred shares of Apple. Do you want to sell that company or do you want to do something differently?" And there are some firms that don't do that, but just keep in mind that they make money on that order flow, because those institutions will pay for that insight. That's another way you're potentially paying for the cost.

One final note is I think you're ahead of the game with asking this question, because I run into folks a lot of times who all they do is think that they need to save to their retirement accounts. They meet the contribution limits, and then they stop saving. They're like, "I'll spend the rest." So thinking about saving additional money to a taxable account is a very good thought. It creates good habits, and it should provide you with a good setup for a good retirement.