Investing

Why Brokers Are Charging No Commissions

By the time markets closed on October first, the Etrade stock price had dropped by over 16% within only 24 hours. After scrapping their commission fees, the online broker warned investors that revenues will decline by almost $75 million. The question here is: Why did one of the most popular trading platforms get rid of its commissions? After all, this is how brokers make most of their income.

The nature of the industry is changing and this move reflects that. Etrade only made the decision after competitors decided to eliminate their own trading fees. Today, brokerage firms make money in different ways, including through banking services and fractional stock offerings.

In the past, investors had to choose between either low costs or high-quality features. Brokers that offered detailed research reports and accurate stock prices also charged hefty commissions. Meanwhile, firms that had low fees provided mediocre banking features and delayed equity quotes.

Even though Etrade stock prices plunged, there are many things that investors should look forward to. Minimal trading costs mean that more people will participate in the stock market. Just as importantly, brokers have to compete for clients by improving and expanding their existing services. All of this saves consumers time, allows them to realize more gains, and benefits young people.

Fighting for Your Money

Charles Schwab, one of the largest brokers in the world, announced earlier this month that they are removing all commission fees. Moreover, they decided to give traders the option of purchasing fractional stocks. Their clients can buy portions of shares instead of paying the whole price for a single one.

This highlights how many firms are moving towards other revenue sources, as opposed to mainly relying on commissions. Brokers are now competing for consumers through offering banking services, different ways to invest, and access to research reports.

Before Schwab made their announcement, the only available options for low or no commission trading were Interactive Brokers and Robinhood. However, none of these two platforms offers the same analytical content and detailed stock prices that others in the industry do.

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Now, however, investors can enjoy no trading fees while brokers compete through providing superior features and new offerings. During 2018, Schwab’s earnings from commissions were only 8% of their revenue during the entire year. TD Ameritrade and Etrade, on the other hand, made 36% and 27% of their income from commission charges, respectively.

The latter two seem to be in a tricky situation. The drop that the Etrade stock price suffered underlines this. However, it also means that brokers know how important it is to be creative and offer more convenient services. The main beneficiary, of course, is the consumer.

Millennials and the Stock Market

More than 80% of young Americans are worried that Social Security will not have the financial means to grant them their benefits when they become eligible. It should be no surprise that brokers are trying to fill this gap. More specifically, they can cater to millennials who are looking for an alternative to Social Security when it comes to retirement savings.

Amongst young people who put their money in the stock market, almost two-thirds of them (58%) invested in technology companies. After all, companies like Amazon, Google, and Netflix are hallmarks of the tech savvy generation.

The main problem is, however, that these investments are expensive. Amazon and Google are each worth of $1,000 per share. Buying one Netflix stock costs well over $200. Younger workers, who have little to no money saved up, can’t afford these high prices, let alone pay commission on top of them.

In fact, more than half of those who don’t invest in stocks say that they can’t afford to do so. This is where Schwab comes in. When the broker opted to remove trading commissions, the company also announced that they will make fractional stocks available.

For example, instead of buying one Google stock for $1,200, investors can put in $100 or $200 to buy a portion of the company’s share. While other brokers are yet to make a similar move, we can expect them to introduce features that will grab the attention of younger investors.

This allows millennials to reap the benefits that previous generations did by putting their money in stocks. The absence of commissions makes doing even easier and more affordable.

Increased Liquidity

The obvious result of the changes in the brokerage industry is that more people will participate in the financial markets. In turn, this creates more liquidity and makes it simpler to buy or sell shares because of the larger number of available buyers.

Just as importantly, with more investment volume, prices will likely go up at a faster rate. This enables consumers to realize higher returns and in a shorter time.

By eliminating commissions, brokers will have to find new ways to make money. Many pundits believe that there are downsides to this, such as increased interest charges and hidden fees.

These concerns are legitimate but, at the same time, exaggerated. The fact the Etrade stock prices immediately bounced back after their steep decline confirms this.

Hidden Costs: Are They a Problem?

First of all, long-term investors are less likely to be impacted by interest expenses, which are charged when you borrow money from the broker to purchase stocks. Most people who want to grow their retirement or savings account do not engage in risky behavior.

Additionally, unless they have over $25,000 in their accounts, investors will only be able to borrow a limited amount of funds from the broker. The interest fees (as well as spread charges) are mostly incurred by active traders who only hold on to stocks for a period of one or a few days.

Second, because brokers are offering multiple services, other costs will also decrease. More specifically, investors who open an account with a firm that has banking services can save money on transfer fees.

Going back to the Etrade stock price, the broker already provides account holders with a debit card, checkbook, and bill pay features. To offset the revenue gap (created by eliminating commissions), we can expect Etrade to further expand its banking services.

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Instead of having to transfer funds from their bank to the broker, investors can now put their money in one place, which leads to minimal transaction costs. For that matter, many banks already offer brokerage accounts, such as Bank of America’s Merrill Lynch platform.

A New Direction: Etrade Stock Rebounds

Lower investment costs and more features are massive wins for consumers of all ages. More people will be able to reap the benefits of the stock market, especially younger investors.

The absence of commissions means that we can expect to see more liquidity and sharper price increases. While brokers will find other ways to make money, the larger picture benefits most investors. In fact, as online platforms are offering banking services and other competitive features, people can save even more funds by reducing transfer charges and managing their finances from one place.

Less than three weeks after plummeting, the Etrade stock price quickly returned to its previous level. This speedy recovery is likely to turn into an even stronger rally in the months and years ahead.

 

Disclosures:
Haitham AlMhana is an associated member of T3 Trading Group, LLC (“T3TG”), a SEC registered Broker-Dealer & Member of FINRA SIPC. All trades made by Haitham are placed through T3TG.
POSITION DISCLOSURE: Haitham AlMhana does not hold any long or short positions on AMZN, GOOGL, NFLX, ETFC, SCHW, AMTD, or BAC as of the time of the publication of this article.
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