On October 2, 2019, Charles Schwab shook up the finance world by dropping its trading fees, a move quickly mirrored by other firms like E*Trade and TD Ameritrade. While this was great news for consumers, it left many wondering how these firms would stay profitable without fees that had long been a staple of their revenue.
Online brokerages like Charles Schwab have been increasingly functioning like banks. They take the cash in your account, pay you a little interest, and make more by lending it out at higher rates or investing it elsewhere. For instance, they might pay 0.1% interest on your deposits and earn 1.5% by investing that money in something like treasury bonds.
After dropping their trading fees, firms like Schwab aim to attract a larger customer base and, more importantly, their cash. TD Ameritrade follows a slightly different path as it partners with banks like TD Bank, which handle the cash and share the profits from the interest they earn.
Another key revenue source for these brokerages is the net interest margin (NIM) business, where they earn by exploiting the difference between what they earn on investments and what they pay you. While trading fees have been slashed to zero, these companies are leaning more heavily into their NIM operations and betting on increased revenues from margin trading and options.
For individual investors, the era of zero trading fees is like getting free fries at a fast-food restaurant—you still end up buying the rest of the meal. Here’s what you should consider doing to make the most of this new landscape:
1. Evaluate Your Trades: Analyze your past trading decisions critically. With no fees, there’s no financial penalty for trading more, but that doesn’t mean you should. Review whether your past trades have actually benefited your financial goals.
2. Avoid Margin Trading: This can be tempting, especially when trades are free. However, it’s risky, particularly in a high market, as you could lose more than your initial investment.
3. Minimize Cash in Brokerage Accounts: Since brokerages pay minimal interest on cash, keep your money working for you in investments or in higher-interest accounts elsewhere.
4. Watch Out for High Mutual Fund Fees: If you’re using managed funds through your brokerage, check the fees. Opt for lower-cost index funds and ETFs where possible.
5. Educate Yourself and Others: If you’re more experienced, consider using a small part of your portfolio to test strategies or teach others about investing.
The drive to zero fees can make trading more accessible, but it’s vital to approach this new landscape with a strategy that aligns with your financial goals. Manage your investments wisely to benefit from these changes without falling into potential traps like overtrading or poorly managed investments.
