We did it! After a decade-long race to $0, Schwab has drawn first blood…sort of. I mean, like I said, this has been culminating over the past 10 years, so I guess it’s not really “first blood” but more of a “last blood” sort of thing. Now, everyone will have to follow suit.

In July of last year, Fidelity and Vanguard both took huge steps forward in the brokerage fee cold war, accelerating cost cutting so far that the only logical next step was to completely eliminate fees. Indeed, recent tech disrupters like Robinhood have already implemented fee-free platforms, they just lacked the scale to be truly competitive.

So now that the industry has completed its race to $0, what does this mean for investors? First, it should be clear, this is not a game changer. Brokerage fees at Schwab were $5 before last week’s announcement (and will be until October 7th). The people behind these cuts will talk a lot about eliminating barriers to the market:

“Most importantly, it’s the right thing to do for clients, removing one of the last remaining barriers to making investing accessible to everyone and continuing our tradition of challenging the status quo on behalf of individual investors.”

What This Means for Investors

So, what does this sudden removal of fees mean for investors? While it seems like a win for consumers, the implications are more complex than they appear.

• The Good: On the surface, this is a simple win—something that once cost $5 now costs $0. For active traders, this removes a barrier to entry. Since many traders rely on frequent transactions, the absence of fees could improve the overall trading experience, particularly for those with higher volumes of trades.
• The Bad: While the fee removal may seem like a win for retail investors, the real issue lies in how it could impact investor behavior. Brokerage fees, even small ones, often act as a deterrent to overtrading. Without this cost, investors may trade more frequently and could end up making poor investment decisions. Overtrading has historically led to poor performance for individual investors, and the removal of fees could exacerbate this problem.
• The Ugly: While companies like Schwab and others in the industry tout these changes as being “for the client,” the reality is that brokerage firms are still finding ways to make up for lost revenue. Schwab, for example, makes much of its income from net interest margins (NIM) through its bank. However, firms like TD Ameritrade, which do not own banks, are more likely to rely on other tactics such as payment for order flow. This practice involves market makers paying brokerages to route orders through them. While this is not inherently harmful, it does raise concerns about whether brokers are incentivized to encourage excessive trading in order to make more money, potentially putting clients’ interests second.

Transparency and Hidden Costs

For example, Schwab will lose somewhere between $90-$100 million in revenue, but the company will make it back up elsewhere. Schwab, in particular, at least has a fairly clear revenue path. It makes its money on net interest margin through the bank that it owns. Trading fees were a very small percentage of annual revenue, whereas NIM (net interest margin) revenue accounts for roughly 57% of income. I think it’s problematic for retail investors in that Schwab doesn’t really explain this, but at least it isn’t a total mystery. TD Ameritrade on the other hand, does not own a bank. The company has some affiliate banking partners but still only receives 28% of its income from NIM.

One-way firms like TD might augment their revenue is by payment for order flow. This is when a market making institution pays a brokerage firm to route its orders through them, typically in order to make another trade on the other side of the transaction. Specifically, if a stock is trading with a spread of $3 between the bid and ask, then a market maker would pay $1 to have a retail trade routed to them. It would then keep $2 and immediately sell the stock to someone else. In reality, these spreads are more like fractions of cents, and the paying firm is executing trillions of these trades a day, but the fundamental issue is the same – in this world, brokerage firms are potentially incentivized to encourage people to carry a lot of cash and trade a lot.

Like most incentives, this is fine…if it is clear to the customer, and everyone plays by the rules. It’s worth noting, last year TD Ameritrade was accused of putting market makers ahead of its clients (https://www.wsj.com/articles/judge-oks-class-action-lawsuit-against-td-a…). This means instead of routing trades to give customers the best price, the company may have routed trades to the dealer that paid the most.

Conclusion

One final note of relevance; we live in an age where one of our most precious resources is our personal data. More and more companies are choosing to exploit our privacy. Someone once said, if you are not paying for it, you are not the customer. You are the product being sold. I don’t know if this will turn out to be prescient, but please keep in mind that brokerage firms will ask you for your income, total assets, social security number, and a host of other personal information. As always, it pays to do business with companies that will take your privacy seriously.

Also,

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  • These 7 Social Security Myths Just Aren’t True, No Matter How Often You Hear Them

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