Like encyclopedias and long-distance phone calls, the once-lucrative business of trading stocks has just seen its price go to zero.
Charles Schwab, which had been charging $4.95 per trade, announced a zero-commission policy last week and was quickly followed by TD Ameritrade and ETrade. The online brokers have other ways of making money, so they won’t necessarily go the way of World Book and MCI, but the moves caused a big hit to all three companies’ stock prices.
The race to zero seemed sudden, spurred by the popularity of commission-free trading app Robinhood, but it’s been building for decades. Before 1975, when Congress abolished fixed commissions, brokerage firms charged hundreds of dollars to execute a stock trade.
Charles Schwab dropped that to $70, and ETrade pushed the going rate to $40 in the early 1990s. By 1998, $7 internet trades at St. Louis-based Scottrade, which would eventually be acquired by TD Ameritrade, lowered the bar yet again.
The firms can argue about who provides better service, but trading is a commodity. Competition tends to push commodity prices down to their marginal cost of production, which is near zero for executing a stock trade.
Stock trading isn’t the only financial product with a vanishing price. Fidelity launched index mutual funds last year with expense ratios of zero, and startup SoFi is waiving all fees on a pair of new exchange-traded funds.
“From an individual investor perspective, you can’t think of this as anything but positive,” says Norman Conley, chief investment officer at JAG Capital Management in Ladue.
Investors should realize, though, that free accounts can still be lucrative for the firms that offer them. Firms make money by lending securities in customer accounts, reinvesting customers’ idle cash and making margin loans to customers who invest using borrowed money. They also collect rebates for routing their trades to electronic market makers.
In fact, commissions were a minority of revenue last year at all three firms — 36 percent at TD Ameritrade, 17 percent at ETrade and just 8 percent at Schwab.
Still, giving up that money will hurt — and may lead to further consolidation among discount brokers. “This is a game of scale,” says Larry Swedroe, chief research officer at Buckingham Strategic Wealth in Clayton. “The larger you are in a commodity business, the lower your costs are.”
“It’s probably a matter of the largest surviving,” adds Michael Flanagan, an independent securities industry analyst in Philadelphia.
The effect on full-service brokerages, like Merrill Lynch or Wells Fargo Advisors, is less clear. For years, they have been de-emphasizing commissions in favor of fee-based advisory accounts.
“This makes it imperative for them to focus more than ever on their advice,” Flanagan said.
It’s an open question whether Robinhood, the five-year-old firm that touched off the latest round of the fee war, can withstand the competition from larger companies. Venture capitalists valued Robinhood at $7.6 billion this summer, but that was when its free trades were still a novelty.
“Their valuation today is probably less than it was,” Conley says. “The zero-commission thing was a big lever for them.”
The biggest questions, though, surround the firms that have just given up a chunk of their revenue. Charles Schwab, TD Ameritrade and ETrade were the brokerage industry’s disrupters for decades, but now they’re the ones being disrupted.