What Wall Street Doesn't Want You To Know
What Wall Street Doesn't Want You To Know
By:Josh Fabian
You’ve heard it before: “buy and hold.” If you’ve tuned in to Truth or Skepticism, you’ve heard Tom Sosnoff and Dylan Ratigan debate passive versus active investing. One of the most common ways to passively invest is buying a no-load mutual fund that mirrors an index. Firms that manage these funds may not charge a “load” but they charge expense fees.
Myth Buster: no-load mutual funds cost nothing to own.
It’s not true. Mutual funds buy and sell products to create a portfolio. Funds are specific about the mix of products they can own. They might also have limitations on types of products they own. For example, funds might be barred from owning junk bonds or stocks under a certain price.
Let’s assume for a moment you own a no-load fund mirroring the Dow Jones Industrial Average. Creating and maintaining that fund requires a lot of trading as people buy shares of the fund and redeem (sell) them. Also, as companies are added or removed from the Dow, funds have to adjust their portfolio to mirror the index.
Payment for Order Flow
Trades required to keep a fund current have an associated cost. Someone is paying for those trades but who that “someone” is might surprise you.
On Wall Street, there is a common practice known as “payment for order flow.”
Here's how it works: In March 2015, Apple was added to the Dow, replacing AT&T. To maintain balance with the Dow, funds had to buy shares in AAPL and sell shares in T. Those trades cost commissions, right? Have you ever done a trade and not been charged commission? Me neither.
Guess what, your no-load fund charged you too but they call it an expense fee. Wait it gets SO much better.
When your fund buys Apple and sells AT&T, someone is taking the other side of those trades. Chances are, the firm running your fund is not the one doing so because of the risk exposure. To mitigate that risk, your fund company may use a third-party to execute trades. Not only do third-party firms execute those trades but they actually pay your fund company for those trades!
This business model between brokerage/fund companies and third parties is very much like the model used by casinos and “high rollers.” Casinos entice gamblers to gamble at their casino. They may offer free food, a free room, or other perks like a free round-trip flight. The cost of these “comps” are nominal compared with how much money the casino may potentially make once that high roller sits down at the tables. They are essentially buying business.
The truth is, expenses associated with transacting all those trades often do not even exist. But your fund company charges a fee as if they do. In reality, your firm may be paid for their business while at the same time, charging you an expense fee. Passivity does indeed pay, just not for retail customers.
If you don’t believe me, ask yourself this simple question: How do no-load fund companies make money? This isn’t exactly an industry known for being unprofitable.
Josh Fabian has been trading futures and derivatives for more than 25 years.
For more on this topic see:
Truth or Skepticism with Dylan Ratigan: November 5, 2015
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
tastylive content is created, produced, and provided solely by tastylive, Inc. (“tastylive”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, digital asset, other product, transaction, or investment strategy is suitable for any person. Trading securities, futures products, and digital assets involve risk and may result in a loss greater than the original amount invested. tastylive, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastylive is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparisons, statistics, or other technical data, if applicable, will be supplied upon request. tastylive is not a licensed financial adviser, registered investment adviser, or a registered broker-dealer. Options, futures, and futures options are not suitable for all investors. Prior to trading securities, options, futures, or futures options, please read the applicable risk disclosures, including, but not limited to, the Characteristics and Risks of Standardized Options Disclosure and the Futures and Exchange-Traded Options Risk Disclosure found on tastytrade.com/disclosures.
tastytrade, Inc. ("tastytrade”) is a registered broker-dealer and member of FINRA, NFA, and SIPC. tastytrade was previously known as tastyworks, Inc. (“tastyworks”). tastytrade offers self-directed brokerage accounts to its customers. tastytrade does not give financial or trading advice, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastytrade’s systems, services or products. tastytrade is a wholly-owned subsidiary of tastylive, Inc.
tastytrade has entered into a Marketing Agreement with tastylive (“Marketing Agent”) whereby tastytrade pays compensation to Marketing Agent to recommend tastytrade’s brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastytrade. tastytrade and Marketing Agent are separate entities with their own products and services. tastylive is the parent company of tastytrade.
tastycrypto is provided solely by tasty Software Solutions, LLC. tasty Software Solutions, LLC is a separate but affiliate company of tastylive, Inc. Neither tastylive nor any of its affiliates are responsible for the products or services provided by tasty Software Solutions, LLC. Cryptocurrency trading is not suitable for all investors due to the number of risks involved. The value of any cryptocurrency, including digital assets pegged to fiat currency, commodities, or any other asset, may go to zero.
© copyright 2013 - 2024 tastylive, Inc. All Rights Reserved. Applicable portions of the Terms of Use on tastylive.com apply. Reproduction, adaptation, distribution, public display, exhibition for profit, or storage in any electronic storage media in whole or in part is prohibited under penalty of law, provided that you may download tastylive’s podcasts as necessary to view for personal use. tastylive was previously known as tastytrade, Inc. tastylive is a trademark/servicemark owned by tastylive, Inc.