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STA Weekly Report – The Impact of Zero Trading Costs

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INSIDE THIS EDITION:
The Impact of Zero Trading Costs
Weekly Snapshot of Global Asset Class Performance
Medicare Open Enrollment Started October 15th
401k Plan Manager

The Impact of Zero Trading Costs

Over the last several weeks, we have seen several brokerage firms and custodians eliminate the transaction costs associated with equity and options trades. The first to do it was interactive brokers and since then our two custodians, Fidelity and Schwab, have announced similar price cuts to remain cost-competitive. Of course, this has major implications not only for these firms but also for investors that transact through their platforms.

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Firms fight for Market Share

First, for the firms cutting costs, these cost cuts are an attempt to at least maintain their market share. The cost to do so, however, is very real as trading fees have historically generated tens of millions of dollars in annual revenues for firms that facilitate securities trading. As an example, we can study trends at Charles Schwab.

As the charts below depict, trading prices can have a sizable impact on the top lines for brokerage firms.  Let’s observe the key takeaways in each of the panels in the chart below. In the left panel, we see the average number of daily trades handled by Schwab over a five-year period running from 2013 through 2017. The trend here was largely flat through 2016 before a jump in the average number of daily trades in 2017. What drove the jump can be seen in the middle panel of the chart which shows a steep decrease in the annual revenue per trade generated by Schwab in 2017 compared to 2016. This seems to indicate that the lower costs per trade lead to a lot more trading activity as the cost friction of executing trades for investors on platforms decreases. For the firms, the further impact is on the top line. As the panel on the right of the chart shows, trading revenues at Schwab have been meaningful historically but have drastically fallen off since 2016 as more no trading cost products have been made available. With the roll-out of zero transaction fee trading across ETF’s and options, we expect trading revenue to nearly disappear for these firms. Based on a recent estimate from Schwab, the estimated revenue lost will be approximately $100M per quarter or approximately 4% of annual revenues.

While that doesn’t sound like a lot, Schwab will want to see that lost revenue recouped via fees charged for other services or increased market share. How this will look isn’t yet known but the bottom line is that the drop-in trading fees to zero will have drastic impacts on these firms and how they operate going forward.

Schwab Trading Statistics

Source: Nasdaq

What do zero fees mean for investors?

The real question for investors is what zero fees will mean for them. First, lower fees can mean that the total returns net of all fees might be slightly higher on an annual basis, especially as periodic rebalancing is considered. Afterall, rebalances across a multiple security portfolio could add a significant cost to annual portfolio management expenses. While the chart below highlights generic fee reductions and the impact on the value of retirement account, the message is similar — Investors might get to keep just a little bit more of the returns earned via their investments.

However, it should be kept in mind that transaction fees as a percentage of total assets have been relatively small, to begin with, so the net impact on total returns might still be only marginal.

Second, investors may derive a big benefit from less expensive opportunities to dollar cost average their portfolio. Again, because the transaction costs will be zero, dollar-cost averaging can be done more frequently to take advantage of temporary share price declines and lower average cost basis. Before zero fees, investors may have seen costs eat into potential returns, especially when this was done in small increments.

Third, as Dan Ariely wrote about in his book “Predictably Irrational: The Hidden Forces that Shape Our Decisions”, it is human nature to use even what you don’t need when it is free. It is possible that investors will find themselves fighting against this human tendency. Afterall, trades will be “free”. An unintended consequence of zero transaction fees may, therefore, be that investors may be tempted to overtrade their accounts.

To balance this urge, it is extremely important that investors keep the word free in perspective. What we mean is that while trading securities might be free from a transaction perspective, trades to sell securities could come with a potentially expensive tax cost – realized short-term and/or long-term capital gains that could heighten tax liabilities.

Source: Rational Standard

This is something that investors will need to exercise discipline with in this new cost environment. Of course, overtrading may also lead to some market impacts like incremental trading volume and liquidity that could be accompanied by higher levels of volatility that also might force overtrading. It could be a vicious cycle for investors if they aren’t careful.

Lastly, and perhaps less obvious is the impact that zero trading costs might have on the interest investors earn on cash balances. Because brokers are cutting prices on transactions, they are looking for ways to offset the loss of revenue as we discussed earlier in the article. One easy offset may be to simply pay even less interest than they already do on the cash you hold in your trading account.  

All of these things, good and bad, mean that the role of the advisor may be even more important for long-term investment success. With the discipline that an advisor can provide, investors may be able to more effectively sidestep pitfalls of zero fees while taking advantage of them for better long-term investment performance. 

Weekly Global Asset Class Performance

Medicare Open Enrollment Period Began October 15th

By Scott A. Bishop, MBA, CPA/PFS, CFP®

What is the Medicare open enrollment period?

The Medicare open enrollment period is the time during which people with Medicare can make new choices and pick plans that work best for them. Each year, Medicare plans typically change what they cost and cover. In addition, your health-care needs may have changed over the past year. The open enrollment period is your opportunity to switch Medicare health and prescription drug plans to better suit your needs.

When does the open enrollment period start?

The Medicare open enrollment period begins on October 15 and runs through December 7. Any changes made during open enrollment are effective as of January 1, 2020.

During the open enrollment period, you can:

  • Join a Medicare Prescription Drug (Part D) Plan
  • Switch from one Part D plan to another Part D plan
  • Drop your Part D coverage altogether
  • Switch from Original Medicare to a Medicare Advantage Plan

Switch from a Medicare Advantage Plan

  • to Original Medicare
  • Change from one Medicare Advantage Plan to a different Medicare Advantage Plan
  • Change from a Medicare Advantage Plan that offers prescription drug coverage to a Medicare Advantage Plan that doesn’t offer prescription drug coverage
  • Switch from a Medicare Advantage Plan that doesn’t offer prescription drug coverage to a Medicare Advantage Plan that does offer prescription drug coverage

What should you do?

Now is a good time to review your current Medicare plan. As part of the evaluation, you may want to consider several factors. For instance, are you satisfied with the coverage and level of care you’re receiving with your current plan? Are your premium costs or out-of-pocket expenses too high? Has your health changed, or do you anticipate needing medical care or treatment?

As a starting point, listen to our interview on the STA Money Hour on maximizing your Medicare benefits. The open enrollment period is the time to determine whether your current plan will cover your treatment and what your potential out-of-pocket costs may be. If your current plan doesn’t meet your health-care needs or fits within your budget, you can switch to a plan that may work better for you.

How do you decide on what Medicare Plan is Right for you?

Source:  2016 Medicare Brochure “Choosing a Medigap Policy”.

What’s new in 2019?

The “Donut Hole” is closing!

Beginning in 2019, Medicare Part D Prescription Drug Plan participants will no longer be exposed to a coverage gap, referred to as the donut hole. Due to changes made by the Bipartisan Budget Act of 2018, Part D participants will see a reduction in their out-of-pocket costs for brand-name drugs from 35% to 25% — a reduction that was originally scheduled to take place in 2020. The gap in coverage for generic drugs will not be closed until 2020. In 2019, Part D participants will pay 37% of the cost of generic drugs.

Also in 2019, the Medicare Advantage Disenrollment Period will be replaced by the Medicare Advantage Open Enrollment Period. The Medicare Advantage Disenrollment Period, which ran from January 1 through February 14, allowed you to drop your Medicare Advantage Plan and return to Original Medicare (Parts A and B) and it allowed you to sign up for a Medicare Part D Prescription Drug Plan. In 2019, a new Medicare Advantage Open Enrollment Period will run annually from January 1 through March 31. If you’re enrolled in a Medicare Advantage Plan, you’ll have the opportunity to switch to another Medicare Advantage Plan, switch to Original Medicare Parts A and B, sign up for stand-alone Medicare Part D Prescription Drug Plan (if you are covered by Original Medicare), or drop your Medicare Part D Prescription Drug Plan.

What’s was new in 2020?

Starting January 2020, Medigap Plans will no longer be allowed to cover Plan B deductibles for those turning age 65.  This should be a minor change since the deductible is currently $185.

A bigger change is that Medigap Plan F, a popular plan which covered all of Part A and Part B deductibles will no longer be offered for those turning age 65 (but it will still be available for those that turned age 65 last year and earlier. Plan G will still be available.

What will you pay in 2020 for Medicare Part B?

Medicare premiums, deductibles, and coinsurance amounts change annually. Here’s a look at some of the costs that will apply in 2020 if you’re enrolled in Original Medicare (Part A and Part B).

According to the Centers for Medicare & Medicaid Services (CMS), most people with Medicare who receive Social Security benefits will pay the standard monthly Part B premium of $135.50 in 2020. However, if your premiums are deducted from your Social Security benefits and the increase in your benefit payments for 2020 is not enough to cover the Medicare Part B increase, then you may pay less than the standard Part B premium.

People with higher incomes pay more than the standard premium. If your modified adjusted gross income as reported on your federal income tax return from two years ago is above a certain amount, you’ll pay the standard premium amount and an Income Related Monthly Adjustment Amount (IRMAA), which is an extra charge added to your premium, as shown in the following table:

Source:  www.medicare.gov

What will you pay in 2020 for Medicare Part B?

Other Medicare Part A and Part B costs in 2019 include the following:

  • The annual Medicare Part B deductible for Original Medicare is $185.
  • The monthly Medicare Part A premium for those who need to buy coverage will cost up to $437. However, most people don’t pay a premium for Medicare Part A.
  • The Medicare Part A deductible for inpatient hospitalization is $1,364 per benefit period. An additional daily coinsurance amount of $341 will apply for days 61 through 90, and $682 for stays beyond 90 days.
  • Beneficiaries in skilled nursing facilities will pay a daily coinsurance amount of $170.50 for days 21 through 100 in a benefit period.

Where can you get more information?

Comparing the Medicare coverage you currently hold to other Medicare plans can be confusing and complicated. It’s important to pay close attention to notices you receive from Medicare and from your plan. Take advantage of helpful resources available by calling 1-800-MEDICARE or by visiting the Medicare website at www.medicare.gov.

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IMPORTANT DISCLOSURES

Financial Planning and Investment Advice offered through STA Wealth Management (STA), a registered investment advisor. STA does not provide tax or legal advice and the information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters or legal issues, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.  These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice. As always, a copy of our current written disclosure statement discussing our services and fees continues to be available for your review upon request.

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