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Can These Online Brokerages Live Without Trading Commissions?

Written by Samuel Taube
Posted October 6, 2019

May 1, 1975 was a day that changed the market forever. That fateful trading session was the first time in U.S. history when brokerages were allowed to charge whatever trading commissions they wanted, instead of the fixed commissions that had previously been required by law. 

Charles Schwab Corporation (NYSE: SCHW) immediately took advantage of the rule change, becoming America’s first discount broker. By charging lower commissions and offering less personalized service, Schwab became the go-to platform for small-time investors and dominated the brokerage industry by the late 1970s. 

In the decades that followed, other brokerages followed Schwab’s example and found new ways to cut costs for investors. 

Deep-discount online brokerages like E*Trade (NASDAQ: ETFC) and TD Ameritrade (NASDAQ: AMTD) used internet servers to automate much of the work that was once done by human stockbrokers — and passed the savings onto investors in the form of even lower commissions.

Then mobile trading platforms like Robinhood and M1 cut costs even further by bundling together similar trades and making their money from short-term lending and sales of user data instead of from commissions. Asset management companies like Vanguard and Fidelity started to offer commission-free trades of their own products.

This “race to the bottom” isn’t exactly new, but it accelerated significantly last week, when Schwab announced that it was completely ending commissions for all online trades of American and Canadian stocks and exchange-traded funds (ETFs). 

Some of its rivals, including TD Ameritrade and Interactive Brokers (NASDAQ: IBKR), have already followed suit in the last few days in order to stay competitive.   

This change is great news for investors who use Schwab, but it’s not so great for other online brokerages and their users. In fact, it could be the beginning of a “retail apocalypse”-like reckoning for the whole industry — one that could put some of the big brokerages out of business and fundamentally transform others. 

Let’s look at what this “brokerage apocalypse” could mean for you and your favorite trading platforms...

If You’re Not Paying for the Product, You Are the Product

It’s worth considering that online brokerages like Schwab still need a way to make money. The end of trading commissions doesn’t exactly mean they’ll let you trade stocks and ETFs for free and out of the kindness of their hearts. It just means they have to find another way to make money off of you. 

Schwab already had its new revenue sources worked out before it announced the end of its trading commissions. The firm will now make money from the expense ratios on its mutual funds and other investment products and from short-term lending. 

But how will its rivals — especially those that don’t have asset management or lending arms — make money in a commission-free world? That’s a trickier question, and there’s no easy answer. But it brings to mind an old adage from the advertising industry: If you’re not paying for the product, you are the product. 

One theory is that online brokerages may shift to a business model based around sales of user data, like Robinhood. The low-cost, millennial-focused investing app earns millions of dollars selling information about individual users' trading behaviors to high-frequency trading (HFT) firms and other financial institutions.

Investors who value their privacy may want to avoid data-selling brokerages.  

Another theory is that some brokerages may get into the investment newsletter business; they might make their money in the same way as... well, Angel Investment Research.

Of course, there’s a big difference between an independent investment newsletter like this one and an investment newsletter that is connected to a broker or financial institution. 

We do not broker, manage, or otherwise control our subscribers’ investments, and that keeps us free of conflicts of interest. Broker-newsletter-publishers might not be able to make the same claim; they might try to steer business toward products they can earn money from.  

Broker-newsletter-publishers might also sell their customer email lists to third-party marketing firms — a practice we avoid. 

In summary, the end of trading commissions could force some online brokerages to do some morally questionable things in order to keep their revenues up. 

But it could kill others.

Some Online Brokerages Depend on Trading Commissions   

Some online brokerages are so reliant on trading commissions for revenue that it’s difficult to see how they’ll get by without them. 

TD Ameritrade draws more than a third of its total revenues from commissions and transaction fees, and E*Trade earns a similar proportion of its revenues from commissions. 

Both firms have seen their stock prices fall off a cliff in recent days following Schwab’s announcement. 

online brokerages, trading commissions

Will these firms be able to rejigger their business models before it's too late? Is this a buying opportunity, or are their stock prices headed even lower? 

No one knows — but one financial services expert who could have the answer is Briton Ryle. His subscribers at The Wealth Advisory locked in a quick 31% gain last year on a certain asset management firm, and they’re currently up more than 230% on a certain bank. Click here to learn more. 

Until next time,

Monica Savaglia

Samuel Taube

Samuel Taube brings years of experience researching ETFs, cryptocurrencies, muni bonds, value stocks, and more to Wealth Daily. He has been writing for investment newsletters since 2013 and has penned articles accurately predicting financial market reactions to Brexit, the election of Donald Trump, and more. Samuel holds a degree in economics from the University of Maryland, and his investment approach focuses on finding undervalued assets at every point in the business cycle and then reaping big returns when they recover. To learn more about Samuel, click here.

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