Free Stock Trades Can Make You Lose Money. Here’s Why.
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Have you ever found yourself buying a t-shirt that you would never normally be seen dead in, simply because when you walked into the store, you saw the sign, “Buy one, get one free”? And what about the window-cleaning gadget that you picked up from a street vendor for only $2 because he promised you that this was a bargain price and it would do wonders for your windows? Both of these purchases were totally useless, and you will probably consign them to the garbage next Pesach. But you still bought them. Why? Because they were either totally free or cost you next to nothing.
Similarly, when you are stock trading, have you ever been tempted to invest in a commission-free trade? These sound really great. You can choose your investment and if you put in a certain minimum, you don’t need to pay brokerage fees. Wonderful – you are saving money. But are you really?
Dan Ariely, a researcher specializing in behavioral finance, talks about “the power of free.” This is when people are tempted to be more reckless simply because the offer is free. Dan noted that when a New York nightclub offered free tattoos to its customers, even though the conditions were very far from optimal cleanliness, many of them actually took up the offer. In fact, his researchers discovered that 68% of those who received tattoos would not have bothered if they had not been free.
When you pay a fee for stock trading, you are less likely to be reckless because the thought of wasting these few extra dollars on something that may not work acts as a deterrent. But when you get a free trade, you may find yourself feeling similar exhilaration to a gambler in a casino. When the roulette wheel spins and he wins a little money, he takes it and throws it back into the game – promptly losing everything. Falsely, he thinks that as he won once, he can keep on winning. A free stock trade, in the eyes of many, has to be a good deal by virtue of the fact that it’s free, but that is not necessarily the case. While you may win some, you are just as likely to lose.
Secondly, you should always ask yourself the question of why something is free. Take a closer look at it. For example, if you are offered an ETF (Exchange Traded Fund) without needing to pay a commission, why is this? Perhaps it is because the ETF is in some niche segment that you would never normally consider and is far less lucrative than other types of ETFs. It is therefore extremely important to remember that even though such a trade is offered as a free deal, nothing has changed about the underlying investment.
The “power of free” is definitely an absorbing subject. If you want to avoid getting sucked into low-quality trades or landing up with a free jar of free lemon chutney when you purchase a hideous red plastic vase for half price at the supermarket, learn more by watching Dan Ariely on YouTube, where he discusses this subject at greater length.
tell a friendAbout the Author: Douglas Goldstein, CFP®, is the director of Profile Investment Services, Ltd, a financial planning firm located in Jerusalem. He specializes in working with clients in New York, Florida, and Israel and is a licensed financial professional both in the U.S. and Israel. Securities are offered through Portfolio Resources Group, Inc., Member FINRA, SIPC, MSRB, SIFMA. Accounts carried by Pershing LLC., Member NYSE/SIPC, a subsidiary of The Bank of New York Mellon Corporation. Neither Profile nor PRG gives tax or legal advice. Before immigrating to Israel, it is advisable to consult with a tax attorney who is knowledgeable about Israeli law. Doug’s newest book The Expatriates’ Guide to Handling Money and Taxes is available at www.expatguidetomoney.com. He hosts a weekly finance show, Goldstein on Gelt, on internet radio. Listen live or download podcasts. Toll-free from U.S. 1-888-327-6179, Jerusalem: (02) 624-2788. Follow on Twitter: @DougGoldstein or contact at doug@profile-financial.com.
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