Sunday, September 12, 2021

The Cost of Investing In A Free Brokerage Firm...

The advertising of online brokers with zero commissions hooks has increased in the last year and even more so if what they offer the investor is to bet on cryptocurrencies. These assets, which generated mistrust when bitcoin emerged, have proliferated and offer investors high returns, although in exchange for high volatility. Behind both issues is, like practically everything that has happened in this year and a half, the pandemic.

"When sports betting was limited, there were many people who saw in the financial markets an opportunity to move money or maintain the regular activity they were doing through sports betting, but linked to the evolution of the stock market," explains Darío García, analyst at XTB. To this factor, Tali Salomon, eToro's regional director for Iberia and Latin America, adds the confluence of other circumstances, "such as zero or negative interest rates or the acceleration of the adoption of digital technologies". This is where we see the Reddit phenomenon and the role that social networks have played, leading hedge funds to lose billions of dollars to try to compensate for the operations of numerous retail investors who shot up the shares of companies that were practically bankrupt in the stock market in just one day.

However, these investments, which may seem very juicy and offer very high short-term profits, also have their risks, which lie in two fundamental issues: by facilitating these operations with technology, anyone with a minimum of capital - and even asking for loans, explain eToro - can invest, without having knowledge of the financial market and therefore risking heavy losses. On the other hand, not all platforms offer investors the security they should guarantee, nor is trading on them as commission-free as they promote.

When opting for one broker or another, it is necessary to observe the fees linked to the operations, which tend to vary if they are for shares in the Spanish market, European or U.S. stock exchanges; those relating to custody - maintenance of the shares - and those applied to the collection of dividends. The most aggressive platforms, such as eToro, Robinhood or Ninety Nine, among others, exempt the client from all these expenses. The first two also offer the possibility of buying fractional shares, which allows you to invest without making a large outlay, another attraction for these retail investors.

Meanwhile, brokers have disassociated themselves from the banking business: "As they have a much more complex and therefore more expensive cost structure, they are less profitable when it comes to operating because they have associated costs which, in order to begin to obtain personal profitability, you first have to cover costs - commissions - which the banks cannot afford not to charge," explains García.

Thus, the banks' fees are mainly aimed at large investors, with fixed prices for capital of up to 15,000 or 20,000 euros, and variable prices depending on the amount invested for higher amounts. Thus, an investor who decides to bet less than 2,000 euros using one of their platforms will face costs of between 3 and 10 euros - if the shares are listed on the Spanish market, otherwise it becomes more expensive - to which must be added the custody fee, which can amount to a minimum of 20 euros per year, and the dividend collection fees, of between one and two euros.

The question then arises as to where the income from free brokers comes from to make them profitable businesses. And the answer is that their use is not 100% free. The CEO of Ninety Nine, Javier Sanz, explained in an interview with CincoDías that their income comes from the cost of currency exchange. eToro, for its part, although it exempts clients from essential commissions, does not exempt them from others such as currency exchange, as well as charging the client for withdrawing funds. In addition, for special assets, such as CFDs, it includes a charge for spreads, i.e. the difference between the bid and ask price of an asset, as well as commissions for positions that remain open overnight.

Totally different is Robinhood's business model, the nature of which makes it unfeasible in Europe due to Mifid 2 regulations. And the fact is that this platform acts as an intermediary: it sends user orders to market makers in exchange for payments, a practice known as payment for order flow, and in the case of cryptocurrency trading, transaction rebates. This causes Robinhood to charge a commission and the final share price paid by the investor is not the market price, but higher by including this extra fee.


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