With the deregulation of brokerage commissions in May 1975 Charles Schwab Company emerged as the leader of what would become a revolution in stock market access for the masses.
By 1980 Schwab was the first to offer 24-hour quote service and was the first to offer 24/7 order entry and quote services in 1982.
In the years following, with the emergence and success of many online brokers, an ongoing competitive push has been on to reduce fees for customers and thus open the markets to many, many more individuals and families.
On October 1st, 2019 Charles Schwab Company announced that as of October 7, 2019 it will drop trade commissions for stocks and Exchange Traded Funds from $4.95 to zero.
On options trades, the base commission of $4.95 has also been removed but traders will still pay $0.65 per contract.
Later in the day TD Ameritrade got on board and terminated its $6.95 per stock or ETF trade commissions.
Options trades at TD will also cost $0.65 as of October 7.
The next day, October 2nd, E*Trade joined the party and matched the actions of its rivals.
It seems that Chuck Schwab set off a firestorm in the industry.
But one of its smaller brethren, Interactive Brokers may have provided the latest spark when it previously announced its IBKR Lite service that offers free trades on stocks and ETF’s.
Merrill Edge has given its clients 100 free stock and ETF trades per month but requires $20,000 to get started.
Robinhood which always offered free stock and ETF trades made the leap and now offers completely free options trades as a cherry on top.
How Do They Do That?
Firstly, we should consider that these fees have been notching down for years. The competition for the now huge private investing and trading market has been fierce and brokerage companies have been forced to get creative in order to attract customers.
Next, most brokers make the majority of their money from different financial activities. Returning to the example of Schwab, in 2018 it made only 8 percent of its revenue from trading commissions. Thirty two percent of Schwab’s revenue came from the asset management business while 57 percent came from interest income on client’s money that it holds.
Other brokers like TD Ameritrade will be harder hit by this new climate as they and many others have a far greater reliance on trade commissions.
Paying less for trades is very pleasant. It feels nice. I would be looking forward to my first freebie on Monday but Schwab was already giving me free trades (don’t tell anyone). If your broker was charging on Friday you may be happy to find that your next trade will cost you far less or even zero. Along with no commissions another benefit comes to mind that will particularly bear on investors. With no commissions an individual will be able to more easily dollar cost average into individual positions. It will now be feasible to buy one share at a time without being hampered by a commission. If you find enough spare change under the couch pillows and car seat you might just go buy a share of stock.
Business machinations and expediencies being what they are I expect that there will be adjustments coming in the industry to offset the coming pain for some of them. For example, to offset the revenue loss some brokers may sell their order flow. This somewhat shady but not yet illegal practice allows other traders on a platform to see what trades are being placed by the crowd, allowing the quicker traders to take advantage by essentially stepping in line in front of others. This could at some point have impact on limit orders and so on. This practice is already common with Robinhood. The newly minted zero commission brokers may be forced to follow. We shall see.
Brokers could also decrease the interest they pay their clients on cash held in their accounts. Though mostly paltry at the present time we could see even more downward pressure on the rates we receive as customers. Brokers, of course, make money by loaning to customers for trading purposes. It may well be that folks will now feel inclined to make more trades and use more margin (borrowing from broker) and wind up paying more fees.
By keeping discipline this price war in the brokerage industry is a boon for us. But like the credit card industry, the brokers will surely be quite inventive in making up their short-term revenue declines at the expense of some customers. We had best keep our eyes open.