HOW FREE IS FREE

​I drove past a business in town and noticed a big tent with banners advertising free hotdogs. In the parking lot stood quite a long line of people waiting for their food. I chuckled when I recognized many successful acquaintances in that line. I thought on the uniqueness of the situation. These well-heeled individuals were willing to wait 20 minutes in line for a free hot dog worth less that a buck. Everyone loves a great deal and especially if it’s free
 
The human desire for “free” has been amplified by our digital world wherein so many services are offered for free, that we have come to expect it. How do you feel when a hotel, restaurant or business does not offer free internet? Though it costs money to provide this service, we don’t want to pay for it. When people order packages online they want free shipping, and free returns. Airplanes used to charge for movies but today, if there is a movie screen in front of your seat, the movies better be free.
 
As a teen I used paper route money to buy Atari video games, but now the biggest video games are offered for free online. Of course, once you start playing you quickly find there are unlimited things to buy within the game if you want the experience to be worthwhile.
 
The financial industry is going through a similar free cycle. Major investment firms have been offering free accounts, free online information and free trades. I have heard it called “The Race to Zero,” as firms seem to be competing over who can offer the most free stuff. Ultimately, we all know there is no free lunch.
 
It costs money to handle investor accounts and to place trades. If a firm offers free trades, then you should do your research and learn how they are covering those costs. Most likely they are using a practice known as “order flow” to do so. In the simplest of terms, order flow is a payment made to a brokerage firm for directing orders to a specific party for trade execution. The spread between the bid and ask price of traded stocks, gives the trader some room to build in profit for himself. He may share some of those profits with entities that direct trade orders to him. This relationship has the potential for a conflict of interest.
 
So, one question clients should ask a firm who is offering free trades is, “Will I end up paying more for stocks than if I just paid a fee to place the trade?” The answer to that question will vary based on the circumstances but investors must all start with the understanding that businesses do not work for free. Understanding how they get paid, and how much, is critical to a transparent relationship.
 
Hot Dogs, movies, video games and investments services all cost money to produce. Educating yourself as to where the money is coming from will help you decide just how free they really are.