Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

For regular SAA and TAA portfolios, the next re-balance will be on Monday, October 14, 2019. You can also find the re-balance calendar for 2019 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Please note that we now list the next re-balance date on every portfolio page.

Zero Commission Era Has Arrived, Is It Really That Good?

Last week, something interesting happened: Interactive Brokers and then Schwab announced zero commission stock and ETF trades. This led to many other firms like TD Ameritrade, ETrade and Ally to follow suit. By now, other than Fidelity and Vanguard, all major brokerages have offered some form of unlimited commission free stock and ETF trades. So it does seem that the era of unlimited commission free stock and ETFs trade has arrived. 

On the surface, this seems to be an exciting news. But is it really that good?

Some background

Of course, unlimited zero stock commission is not new. The most representative one before the news last week was Robin Hood, a firm that tries to cater millennial investors by offering zero commission. Merrill Edge offers 100 free stock and ETF trades a month to its platinum tier customers. JP Morgan’s new youinvest also offers some forms of large free commission trades. 

And then we certainly have many forms of commission free ETF trades from firms like TD Ameritrade, Schwab, Fidelity and Vanguard. 

However, zero commission trades do not necessarily improve your investing/trading cost. Obviously, brokerages need to make money. So if they get rid of commissions, where else do they get their revenue from?

As we pointed out previously in July 8, 2019: Surprise! Brokerages Make Most From Your Cash, Not Commissions, Schwab, for example, only had about 6% or so revenue coming from trade commissions. Other firms like TDAmeritrade or ETrade have gotten 20% or even higher of revenue from commissions. In Schwab case, the majority of its revenue came from so called net interest revenue, i.e., the interest difference made from your cash.

Regardless, these firms need to make up their lost trade commission revenue. One of the avenues is the so called Payment For Order Flow (PFOF), a notorious but not so easy to understand concept. 

Payment for Order Flow 

Investorpedia described PFOF history: 

Ironically, payment for order flow is a practice pioneered by Bernard Madoff — the same Madoff of Ponzi scheme notoriety. During its existence, the practice has mostly been shrouded in controversy. But its allure is too strong, with even the New York Stock Exchange adopting it in 2009.

In a nut shell, PFOF means your broker gets pay from another wholesale broker by routing your order to them. Bloomberg describes it as follows: 

The most (in)famous wholesalers in the above picture include market makers and high frequency trading firms like Citadel Securities. Notice that the definition of ‘best execution’ does not only guarantee ‘the best price’, so there is quite some room for these firms to wiggle. For example, Citadel might be able to fill your orders from its own inventory (itself is a market maker and/or hedge fund operator), even though it satisfies the ‘best execution’ requirement. In essence, these firms make money with arbitrage of the spread of bid and ask. 

In the end, your broker might get not insignificant payments from selling your orders to other firms. You sacrifice the best possible price of your order to get free commission. A very revealing article worth reading is a SeekingAlpha article titled as Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders. In it, the author pointed out, based on SEC filings, that Robin Hood, the free commission broker, actually derived way more revenue (almost 10 times more) from PFOF than firms lik TDAmeritrade and Etrade. Based on this, the article suggested that Robin Hood probably did so by selling order flows at less advantage to its clients than other firms (thus making more money from it). 

Another criticism of PFOF comes from Michael Lewis’  Flash Boy, a popular book that reveals how high frequency trading firms make money by fleecing small retail investors. 

Interested and technical oriented readers might find the materials cited above are interesting to read at least. 

In a word, zero commission trades do not necessarily mean better or lower investment cost. We have yet to see (for example, by examining future SEC disclosures) whether brokers will recoup their lost commissions from things like PFOF. At any rate, retail investors who do too frequent trading, are definitely at a disadvantage position, commission free or not.  To counter this, it’s better to stay in very liquid, low cost ETFs for your investments. As for our portfolios, we have always advocate only investing in broad base, low cost and liquid ETFs such as Vanguard’s total stock market index ETF VTI. 

Market overview

Now we are entering earnings report period. Based on Factset, it’s estimated that S&P 500’s earnings in the last quarter will decline -4.1% over a year ago. If this holds, it’ll be the third straight quarter when S&P 500 earnings decline year over year. Furthermore, manufacturing sector has experienced contraction last month. For now, investors are pinning their hope on a good outcome from US China trade negotiation as well as Federal Reserve’s interest rate cut.  With stocks being very much overvalued by various metrics, we believe it’s important to be risk conscious and stay the course in portfolio management. 

For more detailed asset trend scores, please refer to 360° Market Overview

In terms of investments, even after the recent retreat, U.S. stock valuation is still at a historically high level and a bigger correction is still waiting to happen. It is thus not a good time to take excessive risk. However, we remain optimistic about U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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