How Do Brokerage Companies Make Money?

How Do Stock Brokerage Firms Make Money in 2021?


How online discount brokerage firms make money? How investment firms generate revenue/profit on fees, margin accounts, and cash balance?



Overview


Many of the largest online brokers have a multitude of ways to make money on what is a growing segment of traders looking for a self directed investment platform. Having made the departure from the full service broker, where customers would call the broker and ask them to place a trade manually, the online broker still finds ways to make money in the modern electronic marketplace.


How Do Discount Brokerage Firms Make Money?


  • Commissions on trades
  • Their own mutual funds and ETF's
  • Portfolio management charges
  • Various fees


Commissions on Trades: A Volume Business


The commission structure is one of the most attractive features of an online broker, where for as little as $0.00-$5.00 a retail trader can purchase directly thousands of stocks, ETFs and mutual funds. These trades are placed right on the broker’s website or trading platform, and it is not necessary to speak to anyone as long as the funds are available in the account. Although the profit margin on this kind of discount commission is small, there are no real incremental costs for the broker. The system is live everyday, and the central cost is to maintain the electronic order routing system and web based trading platform.

As long as the system is working correctly, each trade is a profit, and the volumes of trades are where the real money is made. For example, TD Ameritrade has over 11 million customers, and at some point all of them are going to buy and sell an investment product. Some traders, such as those in the futures market, may make 10 to 20 trades per day, with each round trip bringing in a $7 commission.

The key to the system is that the customer service and broker advice requirements are low, while technical support becomes a priority. Traders are doing their own research and making their own decisions, and a high salaried expert in stocks or bonds is no longer needed. Companies like TD Ameritrade and Charles Schwab do have full service brokers available, but if you want to do it the old fashioned way then the commission jumps to $40 or $50.



Marketing Their Own Portfolio or Mutual Funds


Some online brokers, notably Fidelity and Vanguard, have an extensive collection of their own mutual funds or portfolio management funds offered to customers. In all cases, there is a management fee involved with these funds, either charged outright to the customer, or contained within the cost structure of the fund.

These types of funds can be a nice option for the hands-off investor who wants a steady return that someone else is watching for them. The fee is typically .05% up to 1.5% for portfolio management funds, and the mutual fund products will have some kind of fee built in. The mutual funds are often offered ‘commission-free’ meaning there is no broker-associated charge for buying shares, but there are always management fees deducted from the fund’s return to investors.


$0 commissions how do brokerage firms make money


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Various Fees and Profit Centers


Most online brokers will offer margin, or loaned funds, to their qualified customers. They make money two ways by offering margin. First, more funds are invested and traded in the account resulting in more commissions on purchases and sales. Second, the broker makes money on the spread between the margin interest rate charged to the customer, and the amount that they can borrow the money for in the marketplace.

Related to this is the practice of designating cash accounts as FDIC insured money market accounts, which in turn permits the broker to lend out those funds and earn interest. Savvy investors will decline this type of account for various reasons, and instead select the SIPC designation that insures the account as a higher limit investment account.

There are ancillary services that many of the largest brokerage firms offer as part of their services including banking, insurance, trader education and resource tools for their trading platforms. In an indirect way, these are profit centers since they help retain the customer and their account balance, and through training and education encourage more frequent trading. Once again, the online broker is in a volume business, not just in terms of numbers of customers, but also in the number of trades per customer.

If a trader develops an interest in options trading, then an educational webinar and training tools will be a good investment for the broker. The eager trader may take their first steps into the options world, only to find out the only sure profit in options trading is the commission paid to the broker.

None of this is to criticize large online brokers for their business model. Customers make the trades willingly and freely, and if the broker eases the path to making a trade then they are providing a service. Account churning now becomes the trader’s responsibility, as the many resources and opportunities for investment gains appear unlimited. The days of the full service broker may have passed, but the largest online brokers have adapted well to the new order of brokerage services.