Brokers: Stock-trading commissions face extinction
The price war between discount brokerages can’t go much further than this, said Annie Massa and John Gittelsohn in Bloomberg.com. In the latest salvo, Charles Schwab last week announced plans to completely eliminate fees on trades, which used to cost $4.95 each. Soon after, TD Ameritrade and E*Trade followed suit, feeling they had no choice “in an intensifying, industrywide war over fees for everything from stock trades to index funds and financial advice.” Schwab is betting it can make up lost revenue by attracting more clients. But the race to the bottom has “some observers wondering whether anyone can win in a business where more and more services are handed out for free.” Schwab, once upon a time, “was the new entrant paving the way for retail investors,” said Tara Siegel Bernard in The New York Times. Now, though, “access to the stock and bond markets has never been easier or cheaper.” Exchange-traded funds have driven management fees far below what mutual funds used to charge. “Roboadvisers” will “build and monitor your nest egg for a tiny fraction of the cost of your grandfather’s financial adviser.” In this environment, “the elimination of trading commissions had been pretty much inevitable.”
“How will brokers make money by executing your trades for free?” asked Josh Barro in New York magazine. The answer is: the same way banks make money. Schwab, which now has a total of $3.7 trillion in client accounts, takes cash deposits from account holders, pays a small amount of interest on those balances, and then earns a lot more interest by lending those balances out. “If Schwab makes its brokerage product more attractive by offering zero-fee trades, that may induce customers to bring more business to Schwab, including more cash balances, which Schwab can earn a net interest margin on.” That net interest margin accounted for 57 percent of Schwab’s revenue last year.
Rock-bottom prices could incentivize overtrading or risky stock bets, said Andrew Keshner in MarketWatch.com. One financial planner warns that zero-cost trades encourage a frequent-trading strategy that makes “most people do poorly, rather than a ‘buy-and-hold’ approach, which would be better.” Speaking of financial planners, said Nir Kaissar in Bloomberg.com, your financial adviser is “Schwab’s next target.” The average “financial adviser continues to collect roughly 1 percent a year on accounts of $1 million, and more for smaller accounts.” Schwab and other discount brokers have already been making a big push into the high-end advisory business. Independent financial advisers, who often use Schwab accounts to trade for their clients, say they love the new commission-free trades. Do they know that Schwab is about to eat their lunch? ■