'Commission-free' investment trading platforms are on the rise - but there's a catch

Investment platforms that offer 'free' share trading are on the rise, but don't necessarily offer good value

At the end of July, challenger bank Revolut launched a free trading platform, offering UK customers the ability to buy and sell shares with “zero trading commission”.

Most other online platforms charge somewhere between £4 and £12 per transaction.

Revolut is not alone in offering this. It follows in the footsteps of a handful of other online brokers that are also dangling the carrot of free trades, including eToro, Freetrade and Trading212.

In early August, US fintech giant Robinhood also announced that it plans to offer zero commission trading services to UK customers.

On the surface, the proliferation of commission free trading platforms appears positive.

One of the soundest pieces of investment advice is to try and keep fees to a minimum. As Vanguard founder Jack Bogle often said, you can’t predict market returns but you can control the fees you pay.

Often this primarily applied to the fees that funds and investment trusts charge, but the fees paid to platforms also mount up over the long term.

This prompts the question, is zero commission trading a good idea?

First, the banner of “zero commission” trading is often used as a way to draw customers in, with the hope being that some users will actually end up opting for more expensive premium accounts.

This is done through offering free trading operated on a tiered model.

For example, Freetrade offers customers the ability to either trade on their account for free, but their order will be bulk processed with other customers once a day. Those wanting instant trading pay £1.

Revolut offers a slightly different subscription service, with each of its three tiers each offering a different number of free trades per month.

Customers can opt for the standard account (which is free), a premium account (for £6.99 a month) and the metal account (£12.99 per month).

There is nothing inherently wrong with this – customers are at liberty to chose for themselves whether they need to pay for the premium service or not.

Probably the biggest downside, however, is how restricted the investment universe offered by those platforms offering free trades is.

Often the case is that the sort of investments that should be at the heart of a retail portfolio are notably absent.

Revolut, for example, only offers access to US stocks, listed on the NYSE and Nasdaq. The platform offers no access to passive index trackers, actively managed funds and investment trusts. For most investors, these are the most appropriate products to invest in.

Similarly, eToro offers access to esoteric and high-risk products such as cryptocurrencies but not funds or investment trusts (although it does offer ETFs).

It is also worth noting the lack of tax wrappers available. Revolut currently does not offer a stocks and shares Isa, while Freetrade charges £3 per month.  

Finally, investors on zero commission trading platforms can find themselves paying slightly more for the shares they buy if their shares are executed in bulk at a set time of the day. Thus, by not offering trades in real time, investors risk missing out on securing the best price for the shares they are buying.

More established platforms use 'market makers' to execute customers trades.

Market makers are third parties that are willing to buy and sell stocks or other assets to platforms. This often results in the platform being able to provide a lower dealing spread to their customers.

Market makers, though, are not used by zero commission platforms that execute trades in bulk, potentially adding to the price that an investor will pay.

Buying a share: bid-offer spread

Market makers offer two prices for each share they are making a market in. The first is known as the bid price. This is the price they will pay people who want to sell the share.

It can be compared to the process at an auction: you hold some shares you want to sell, and someone bids a price to take them off your hands.

The second price is known as the offer price. This is what you will have to pay to buy the share. The market maker is simply saying: “I can offer you some shares at a certain price.” It is the price that they want to sell the shares to you for.

In order for the market maker to make a profit from trading shares, there is a difference between the selling (bid) price and the buying (offer) price. This is known as the bid-offer spread.

This spread is usually very small for large companies in the FTSE 100, but can be quite big when trading the shares of very small companies.

When you are investing in shares, it is important to understand the bid-offer spread because it is a cost to you. The wider the bid-offer spread, the larger your initial reduction in value will be in buying a share.

This article first appeared on our sister website Money Observer.

To find out more on investing if you are a novice, check the Moneywise First 50 Funds for beginner investors guide