How Do Brokers Make Money With $0 Commission Free Trades?

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

How Do Brokerage Firms Make Money With Zero Commissions?

Have you been wondering how all these brokerage firms nowadays can afford to offer $0 commissions? We were wondering the same thing; so we did some research, and here’s what we found.

The Broker Price War Isn’t New

If you’ve been watching brokerage commissions in the United States come down to $0, you may think that this price war is a recent phenomenon. Actually, the race to the bottom began in 1975 with the passage of the U.S. Securities Acts Amendments. This law prohibited fixed brokerage commissions.

When the bill became law, some brokerage firms actually raised their commissions. But one man, Charles Schwab, decided to lower his—all the way down to $70. Not a huge revolution by today’s standards, but it was a start.

By the year 2000, commissions in the U.S. ranged from $10 to $20; and by 2019, they were sitting at $5. The momentum couldn’t be stopped.

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Brokers Earn Money in Multiple Ways

So how can brokerage firms offer $0 commissions? The answer is that they make their money in several ways, not just by charging for trades. By enticing customers with free trades, they hope to earn money from their customers’ financial behavior in other ways.

For example, most brokerage firms pay little to nothing for idle cash sitting in an account. But like a bank, a broker can use that cash for other purposes. And they do. Brokers lend this money out and invest it, earning much higher rates than they pay their customers for it.

For example, TD Ameritrade currently offers a 0.01% APY on free cash balances in its FDIC-sweep program. The broker’s margin rates vary from 8.25% to 10.25%. That’s a huge profit margin on what the company pays for cash versus what it earns by lending it out.

Broker-dealers also earn money by charging for investment-advisory services. Fidelity customers, for example, pay anywhere from 35 basis points up to 150 basis points per year for the company’s portfolio management.

And then there’s order flow. Trading firms purchase orders from retail brokers. They in turn make money off of the bid-ask spread. So both companies make money from orders without charging any commissions.

And don’t forget all the other account fees. Merrill Edge charges $49.95 to close an IRA, WellsTrade charges $25 for broker-assisted trades, and Robinhood charges $75 to transfer an account.

Last, but not least, keep in mind that most brokers are only offering $0 commissions on stock and ETF trades. Most other products still have commissions. For example, Schwab still charges $1.50 per futures trade (per contract) and $0.65 per options contract. E*Trade charges $19.99 for transaction-fee mutual funds.

$0 commissions how do brokerage firms make money

The Bulk of Most Brokers’ Income Isn’t From Commissions

The percentage of a broker’s annual revenue from stock and ETF commissions is very small. For most firms, it’s less than 20%. Some brokers might be under 10%.

Some Brokers Are Raising Other Prices and Cutting Back on Services

After the price war reached the inevitable bottom, it was quite easy to see how some firms were adapting. For example, when Firstrade went to $0, one of the first things we noticed was that the broker no longer offered human chat service.

Interactive Brokers now offers two account types: IBKR Lite (the new system) and IBKR Pro (the old system that still charges equity commissions). For margin loans, IBKR Pro charges the benchmark rate plus 1.5%. IBKR Lite charges the same benchmark plus 2.5%. And there’s a similar difference on idle cash rates.

You Could Actually Pay More with $0 Commissions

If you use margin regularly, but don’t place many trades, you could actually pay more under the new $0 pricing schedule. The increase in margin rates could outweigh the amount you’re saving in commissions. A margin debit of $14,000 over a one-month period will cost an extra $11.66 in an IBKR Lite account.

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Watch for Additional Fees on Your Trade Confirmations

Brokers will be passing on exchange and regulatory fees that they used to pay on customers’ behalf. These are on the sell side. The SEC fee is $0.207 per $10,000 of principal sold. And FINRA’s sell-side fee is $0.00013 per share.

Open TD Ameritrade Account

Open TD Ameritrade Account