How do brokerage firms make money

How Do Brokers Make Money With Zero Commissions?

With $0 commissions how do brokerage firms make money in 2022? How brokers earn revenue with no fee (free) stock trades?

How Do Brokers Make Money With Zero Commissions?

Brokerage firms offering $0 commissions have become the standard in today’s investing world. Even though this is great news, you may be wondering exactly how brokers still make money without charging any commissions. We are going to explore the behind-the-scenes of how brokers operate and uncover exactly how they are financially surviving and thriving without the income from charging commissions.

How Brokers Make Money Without Commissions

There are many different ways that brokers make money outside of charging commissions. Depending on the broker, commissions may only represent a small percentage of their overall revenue.

The largest brokers, such as TD Ameritrade, E-trade, and Charles Schwab, offer a wide range of financial services that provides them with diversified sources of revenue. The newer, mobile-app-focused types of brokers, such as Robinhood and Webull, have less diversified sources of revenue, but they still have other ways of making money without charging commissions.

There is a long list of ways that brokers, such as the ones mentioned above and many others, are making money without charging commissions. The list includes payment for order flow, asset management, sponsoring mutual funds and ETFs, securities lending, margin loans, 401k accounts, market data subscriptions, idle customer cash, and various account fees. This list is not fully comprehensive however, these are some of the main ways that brokers make money with $0 commissions that we are going to discuss in this article.

How do no fee brokers make money

Payment for Order Flow

Payment for order flow is probably the most controversial way that many brokers make money. Robinhood is infamously known for taking payment for order flow and making huge profits from their customer’s orders. Even though this practice is frowned upon, there is nothing illegal about a broker accepting payment for order flow. Brokers have a fiduciary duty to first and foremost get the best available execution prices for customers on their orders and payment for order flow shouldn’t interfere with this.

The simple explanation of how payment for order flows works is that market makers pay brokers in exchange for sending them orders. Market makers’ entire business model is executing as many orders as they can. To compete against each other, market makers incentivize brokers to send them their orders by giving brokers kickbacks on the orders they send.

Technically, brokers can do whatever they want with the money they get from kickbacks on orders they send to specific market makers. Robinhood chooses to keep this money as profit, which adds to its bottom line. Fidelity also receives payment for order flow however, they use the kickbacks for a program called price improvement. Fidelity’s price improvement program automatically takes the kickbacks received from market makers and passes them along to customers.

Asset Management Fees

Some brokers offer asset management services where they will operate your entire investment portfolio and do everything for you including picking your investments, managing your investments, and providing you with a full-service experience. With an asset management model, the broker doesn’t charge you any commissions instead, you typically pay one encompassing flat fee based on a percentage of the total value of your assets that they are managing for you.

Edward Jones is an example of a broker that specializes in the asset management model. They currently have over 18,000 advisors and they have several different asset management programs available. For instance, their Advisory Solutions Fund Model is a program that begins with an annual fee of 1.35% of your total assets and an additional portfolio strategy Fee that begins at 0.09% of your total assets.

These annual fees cover everything involved with the asset management program including trading costs, the relationship with an Advisor, and investment selection. Asset management programs can cost brokers a lot of time and money on their end to provide all the services for clients, but they can be quite profitable for brokers in the long term.

No Commission Brokers

Sponsoring Mutual Funds and ETFs

Some larger brokers that offer $0 commissions, such as Fidelity, create and sponsor their own mutual funds and ETFs. The expense ratio on the funds covers the operating costs. After the fund takes the expense ratio and covers all the costs, anything left over can go right into the broker’s pocket as profit.

One of the most famous mutual funds is Fidelity Contrafund. The Fidelity Contrafund, symbol FCNTX, currently holds assets of over $126 billion and has a net expense ratio of 0.81%. That means the fund is taking in about $1.02 billion of income from the expense ratio. Even if only a little bit of that income is profit, that is still a huge number.

This is just an example of one fund. Fidelity has dozens of its own mutual funds and ETFs that they sponsor. As you can imagine, this side of the brokerage business alone may potentially bring in enough money to make up for any lost income from not charging commissions.

How do brokers make money without commissions

How Do Brokers Make Money With Securities Lending

Brokers lend securities to their customers, other brokers, and other third parties. Securities lending is different than margin borrowing, which we will be getting into next. With securities lending, brokers provide shares of companies to people who want to short sell them.

To short sell, you first need to borrow the shares of the stock you want to short. There are only so many shares available in the market for people to borrow. For blue-chip companies such as AAPL, there is usually never a shortage of shares available to borrow for short selling because the demand to short AAPL is relatively low compared to the supply of shares in the market. As a result of low demand and high supply, brokers typically don’t charge any fees to short blue-chip stocks like AAPL.

With controversial companies such as GameStop, symbol GME, there can be an extremely high demand for shares that people want to short sell so, the supply of available shares is limited. Due to high demand and low supply, brokers charge fees and/or interest to borrow GME shares for shorting. Brokers can either loan out shares from their own inventory, borrow them from another broker, or borrow them from a customer, and either way, brokers profit from the spread of how much interest they receive compared to their costs of loaning out shares.

How Do Brokers Make Money With Margin Loans

Brokers allow customers with margin accounts to borrow money from them and then they charge customers interest on the loan. Customers can take out margin loans for different reasons including for trading or personal use and either way, the broker is getting paid interest, just like how a regular loan from a bank works. Margin loan interest rates vary greatly from broker to broker, and it’s up to the broker to set their rates based on how much profit they want to make.

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How Do Brokers Make Money With 401k Accounts

T. Rowe Price is an example of a broker that offers $0 commissions on online stock and ETF trades, but the money they miss out on from these free trades they make up for by providing 401k accounts. Providing 401k’s is a business dealing with large companies and institutions that are willing to pay money for this important service. By providing 401k accounts to companies and providing all the services that come along with 401k accounts, T. Rowe Price can charge fees and make profits that could add up very quickly in the big picture.

Market Data & Market Access Subscriptions

Some of the market data that your broker provides you costs them money to get. A lot of brokers will provide you with this data for free, but some brokers choose to pass on the charges, with possible markup, to customers. Examples of data that brokers have to pay for include Level 2 quote data, real-time quote data, and research reports. Depending on the data you need, you could end up paying your broker hundreds of dollars per month for it.

How do zero commission brokers make money

How Do Brokers Make Money With Customer Cash

Your broker pays you interest on any idle cash you have sitting in your accounts with them, although probably not much. You may be surprised to learn that your broker may be using your idle cash to make more money for themselves with it than the interest they are paying you. There are enormously complex rules and regulations around how your broker is legally allowed to handle your cash. However, brokers have found ways to circumvent these regulations in a legal way that ultimately benefits them by allowing them to use your cash for their own investments or other money-making methods.

Various Account & Miscellaneous Fees

Brokers that don’t charge any commissions sometimes have a long list of various account fees and miscellaneous fees that they charge. The list of fees could include things such as transfer fees, account closing fees, or statement fees.

How Do Brokers Make Money With Zero Commissions Conclusion

We touched on some of the main ways brokers make money with $0 commissions in this article and there are plenty of other ways that we didn’t cover. Some brokers may ultimately suffer on their bottom line from not charging commissions, but $0 commissions are definitely here to stay forever. The $0 commissions movement certainly does benefit many investors, but always keep in mind that brokers are a business and businesses exist to make money one way or another.

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Updated on 5/1/2022.

About the Author
Paul Johnson is a Licensed Stockbroker with 7+ years of experience in the financial services industry. Paul enjoys teaching about investing and writing about financial topics. He is a husband and father of twin boys.