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Apparently free brokerage is to blame…

Apparently, the problem with the stock market is that retail investors are screwing things up.

Apparently, they’re taking advantage of free brokerage, and causing merry hell.

Apparently, if we only stopped those ‘know nothing’ investors, all would be okay again.

And in reality?

In reality, it’s a nice combination of ‘bait and switch’ and a fig leaf to cover the sins of the supposed professionals.

Those professionals would have you believe two things:

1. DIY investors are the problem; and

2. Highly-paid professionals are the solution.

I know.

I was as shocked as you are.

Imagine that. We can’t be trusted, but they can!

Well, for a fee, of course.

Have you ever read anything so ludicrous?

Or self- serving?

I mean, it’s not like they’re worried about their fees, right?

Or that they’d benefit (handsomely) from convincing us that we should leave it to the ‘big boys’.

Or maybe they’re just trying to find plausible excuses for getting their stock-picking calls wrong?

Yes, dear Foolish reader, it’s like an adult version of Scooby-Doo:

“I would have been right, if it wasn’t for those meddling kids”

See, all we have to do is stop normal people making their own decisions and…

(Sorry, I fell off my chair in hysterics).

Ah, but you’re biased, Phillips. You just want to get more customers.

Maybe.

I sure as hell want more people to take control of their finances.

To spend less.

Save more.

Invest regularly.

Benefit from the compounding machine that is the ASX.

Yep, guilty as charged.

I just want people to be better off.

So, sue me.

Can’t that be done by those complaining about the ‘distortion’ of the market by retail investors?

I guess.

If they have a long-term track record of beating the market — after fees.

But if that’s true, they have no need to worry about the rest of us.

Indeed, if they’re that good, any so-called ‘distortion’ will just be a massive money-making opportunity for them.

They should be cheering it on!

Confused?

Me too.

I mean, those people did realise the market would recover, right?

And they’ve made a fortune since, right?

Oh….

—–

All of that said — and without stepping back from the criticism one iota — I do worry about the rise of free brokerage but from a very different perspective.

I’ve written about it before, but when even ASIC feels compelled to step in and say something, we need to be careful.

It’s an unpopular view, to be sure: “You actively want me to have to pay higher fees????”

Just put the pitchforks down for a second, and hear me out.

See, any time you consider an issue, you need to think not just ‘rationally’, but through the lens of behavioural psychology.

Let me give you a simple example:

Last time I wrote about this, the subject line of the email I sent included the word ‘free’ (as in ‘free brokerage’).

Such is the power of that word, the email open rates (the number of people who opened the email) doubled.

Yes, doubled.

From — and I’ll use the technical terms here — ‘a lot’ to ‘a helluva lot’.

Shedloads of people opened that email.

(I was so surprised, I actually checked with our tech team to make sure there wasn’t a problem with the report.)

I mean, I’m good. But not that good. (Not even as good as I like to believe. But that’s a whole other issue.)

‘Cheap’ is good.

But ‘Free’ is catnip.

Now, let’s turn our gaze to the free ‘thing’: brokerage.

If something costs money, we value it. We treat it carefully, weighing up our options.

When it’s free? Well, we don’t really care about the object at all, do we?

If I told you something that was previously $2 was now $1, you’d probably buy more of it.

If I told you it was free?

I’d get knocked over in the rush.

The difference is so disproportionate, there is no possible rational explanation.

The ‘extra’ bit? Pure psychology.

And the problem with that?

It’s not rational. We do it because some part of our subconscious brain overrides the rational bit.

Which is fine if I’m giving away lollies.

But if it (unintentionally) encourages people to abandon all caution and day trade like banshees?

Well, I don’t think you need me to tell you how that ends, do you?

And if you think I’m speculating, you’re right.

But I do have some history on my side.

You reckon Australians buy and sell investment property too much?

If you said ‘yes’, you should have seen the Yanks before the GFC.

In activity which fuelled the pre-GFC madness, Americans were flipping property like they were pancakes.

(‘Flipping’ is buying a house, renovating it (or not) and getting it back on a fast-rising market as quickly as possible before doing it all again. The emphasis here is on speed.)

There were TV shows called, I kid you not, First Time Flippers, Flip This House and plenty more.

(An Australian version was tried, and thankfully only lasted a handful of episodes!)

The difference between here and there?

Lots, probably.

But one thing that kept the lid on house flipping here was Stamp Duty.

And yes, I hate paying stamp duty as much as you do.

But I’m pretty sure it saved us — at least in part — from the worst excesses of the GFC (and probably since, as well).

Economists hate ‘friction’ — anything that slows down the rate of activity in a market.

And God help anyone who stands between a hard-core economist or free-marketeer and the chance to remove some friction.

Of course, economists also count hospital visits, panel beaters, and earthquake damage repair in GDP, even though they’re just restoring the status quo (and the ‘cost’ of the damage is never deducted), so let’s just say economic fundamentalism has some, well, issues.

The solution?

I’m not sure I know, with certainty.

The last thing I want is to put a barrier in front of people who would otherwise invest, but for whom the brokerage is a stumbling block, either psychologically or financially.

Perhaps removing the flat “$X per trade” and replacing it with a set percentage would work.

Or maybe we charge people to buy, but let them sell without brokerage.

And you can give the fee to charity for all I care. I have no interest in making stockbrokers rich, but I’m pretty set against making new investors poor by giving them both the incentive and the ability to trade too often, robbing them of the very best part of investing:

Long-term compounding.

Fool on!

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When investing expert Scott Phillips has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for more than eight years has provided thousands of paying members with stock picks that have doubled, tripled or even more.*

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Motley Fool contributor Scott Phillips has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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