Trading traps for DIY investors to avoid
The tax free savings account (TFSA) seems to have spun off a bonus.
In addition to granting investors a tax haven from any market gains, the popularity of the TFSA is stimulating competition among discount brokerages hoping to cash in on the growing ranks of do-it-yourself investors. A recent J.D. Power survey found the percentage of investors with only discount brokerage accounts increased to 33 per cent in 2013 from 21 per cent in 2012.
It’s about time. Canadians already pay much higher trading fees than our American cousins. While trades are generally under $10 in the U.S., many Canadian brokerages still charge as much as $29 per trade – a throwback to the days when trades were manually processed through a complex web of paperwork.
Earlier this month Questrade Canada introduced one-cent stock trades. Before you bite the hook – that’s one-cent for each share and there are strings attached. Questrade only gives the one-cent deal to clients who sign up for its Advantage program. The actual fee is between $4.95 and $6.95 and you have to subscribe to Questrade’s $20 market data package. You only get the $20 back if you generate more than $400 in commissions in a one-month period, and it can only be redeemed in more trades.
Even if you decide not to subscribe to the program, Questrade’s standard trading fee is $9.95.
Royal Bank of Canada’s RBC Direct Investing recently matched Questrade and is also offering the $9.95 per trade deal, no strings attached. Previously, that rate was only given to investor with a minimum account balance or trading threshold.
Other discount brokerages including TD Direct Investing, BMO Investorline and National Bank Direct continue to cling to the $29 standard trade but have lowered it to $9.95 for clients with at least $50,000 in their accounts.
Holding $50,000 could be difficult for TFSA holders considering the total limit on contributions is $31,000, but as a concession all three brokers allow families to combine their savings. In Other words, couples and children over 18 can combine their TFSAs into one pool to get the $9.95 trade deal.
The strings can add up
Most TFSAs don’t even come near $50,000. In those cases discount brokers offer low fee packages based on a minimum amount of trades in a fixed period of time.
Discount brokerages make their money from commissions on trading. The more you trade, the more they make. If their fees are low, they can make up their losses through volume.
That’s where investors with itchy trigger-fingers can get themselves into a heap of trouble. Studies show there is no correlation between trading frequency and trading gains.
In fact, they could be a deterrent. Some of the minimums are in the hundreds of trades each month. At 50 trades, a $10 trade adds up to $500 in trading fees in a month.
For an investor with a $30,000 portfolio that’s a 2 per cent monthly loss before the investment can even begin to generate a return.
Trading fees could more than wipe out any tax savings in a TFSA.
Fees aren’t everything
To add another twist, a recent survey on online brokerages by J.D. Power ranked low-fee Questrade Canada and RBC Direct Investing among the lowest in terms of customer satisfaction, and ranked big-fee brokers including TD Direct Investing, BMO Investorline and National Bank Direct at the top.
In terms of importance, investors chose fees second to a discount brokers ability to provide one-on-one service.
After fees, respondents ranked their discount brokers on being able to provide account information, perks that come with the account, and research tools.
The final consideration was problem resolution.