Consider the media coverage inspired by Bank of America's (NYSE:BAC) decision to offer "free trading" for customers with $25,000 in deposits at BofA:
In a move with huge ramifications for the exchange-traded fund (ETF) industry, Bank of America is eliminating brokerage-trading fees for customers with $25,000 or more in … [deposits]. The free trades will roll out in selected markets like New York and Boston this month, and across the nation by February 2007. Accounts will be allowed 30 free trades a month.
- IndexUniverse.com, “Why Bank of America's New Free Trading Will Change the Industry While Benefiting ETFs”, October 11, 2006
Calling it a "fundamental change" in the brokerage industry, Liam McGee, head of consumer banking [at Bank of America], said it was part of the bank's strategy to persuade customers to give more of their business to … [Bank of America]. .. Mr. McGee declined to say how much revenue BofA would lose initially from the dropped charges but said it was confident this would be more than made up by increased deposit revenue… [emphasis added]
- Financial Times, “BofA steps up battle in online broking,” D. Wighton, October 12, 2006
While much coverage treated the offer as a windfall for consumers (Bloomberg, for example, noted that customers who make 30 trades a month could save as “much as $3,600 a year”), Bank of America’s own spokesman indicated that the program will not be that expensive for BofA.
This prompts at least a couple of questions:
1. How is this possible? How can the customer’s windfall not be that expensive for BofA?
2. Why exactly would a retail customer make 360 equity trades per year, or 1.4 trades every trading day, excluding weekends and holidays.
While I can’t provide an answer to question #2, I do think I can tackle question #1. Any customer considering BofA’s offer would need to evaluate what other alternatives he or she has for the money that would be placed on deposit at BofA in either a CD or a Money Market Savings Account.
If that customer resided, for example, in New Jersey, then the customer could choose among the following on October 12th:
As the table suggests, BofA’s “regular” CD and Money Market Savings rates are below the BankRate averages by roughly 125 to 150 bps. If this difference persisted for an entire year, then the BofA deposit would reduce the customer’s deposit income by roughly $300 to $400 year. Is this a good deal for the customer? I guess it depends upon the number of trades that he or she makes in a year. The careful BofA customer could open what BofA calls it’s “High Yield” CD, with a 7 month term. In that case, the customer will make about $100 more with the BofA account, as noted in the above table.
Note: New Jersey CD rates currently can exceed the national averages. So, the above use of national averages understates the cost of the BofA deposits to a customer willing to “shop around.”
Finally, since this IS an index website, one should note the interest rates currently available at one of the earliest proponents of indexing and low cost investing – Vanguard. The yield on BofA’s Money Market Savings account is less than half that of Vanguard’s Prime Money Market Fund. Over a year, the BofA account would provide the customer about $675 less income than the Vanguard Fund. Is this a good deal?
Now, about those 1.4 trades for each trading day…