Last week, Charles Schwab Corp announced it would reduce online trading costs for stocks and exchange traded funds to zero. Competitors TD Ameritrade and E*Trade immediately responded with similar offers—meaning, no commissions on trades for client accounts. Fidelity's online brokerage responded in kind just today.
Schwab and TD are important partners of ours, serving as custodians for our clients. In this note, we outline the four major implications that we see.
For context, we first make two quick points:
- The trend of removing cost from trading has been in force for over twenty years. What used to cost over $40 per trade had dropped to $4.95 per trade a few years ago, equating to pennies or even fractions of a penny on a per-share basis.
- A little over a year ago, Vanguard announced all trading on its platform would be free, launching the opening salvo in free commissions. Since that time, a few start-ups rolled out free trading, but Schwab as a major player accelerated the “race to the bottom” with its news, forcing rival online brokers to follow suit—arguably sooner than most in the industry expected.
We outline four implications:
- Falling trading costs—inevitably becoming free—is good news for you as an investor. The less you have to pay in trading execution, the more you get to keep. In reality, trading costs have become marginal in the past few years (especially for large orders), but zero commissions now help even the smallest investors. As a firm, we have supported and encouraged this trend in trading.
- Free trading plays to Schwab’s strengths; they now make money in other ways. Free trading essentially closes the final chapter to something Schwab introduced over 30 years ago: affordable trading. Trading commissions now represent about 7% of its revenue, vs. 35% fifteen years ago. Schwab has expanded its business to include banking and broader financial services, so they should be in a healthy position.
- We expect Schwab’s move to pose a major challenge to its smaller competitors in online brokerage. Many derive double or triple the revenue in trading commissions.
- We anticipate a “shake-out” over time as weaker players are forced to exit the business.
- As a firm, we expect to continue to rely on Schwab for its industry-leading custodial services, and while TD will have to adapt to the new regime, we believe their role as custodian remains solid for the foreseeable future.
- As the custodian business evolves, we will continue to thoughtfully optimize yield on cash in client accounts, consistent with the custodian partnership. The benefit to you with our partnering with an independent custodian like Schwab or TD means clients receive highly regulated oversight of their investments to minimize risk of fraud or theft by external parties, including transaction verification, settlement, and detailed reporting on any action taken with client accounts. That said, Schwab (and we anticipate any custodian in banking, for that matter) deliberately uses cash in client accounts (called a “sweep” account, often paying marginal yields) to support its banking business, lending funds at a higher rate for profit. For this reason, we will continue to 1) keep short-term transactional cash (the sweep account) a very small percent of a client’s account value and 2) designate longer-term cash to more strategic vehicles that provide better yield. The short-term cash is important because it provides immediate liquidity for reinvestment or distributions, while the strategic cash can be invested with greater flexibility.
- Removing cost in the investment landscape—not only in trading but also investment management—is a trend that will continue. The investment industry is notorious for hidden fees and high-cost products. We believe that excessive COST is one of the biggest enemies to investor success, and our goal is always to remove unnecessary cost from the system. Broadly, the trend toward low-cost investing—whether through index funds or “robo” or “app-based” investment advice—is here to stay. Our own view is that:
- Automation will play a key and necessary role in removing cost, improving service delivery, and optimizing the client experience; we continue to invest actively in leading technology across those areas.
- Customized, personal guidance by a human—supported by best-in-class technology and innovative partnerships—will be the most effective way to help clients navigate through life’s uncertainties and financial challenges over time.
Bottom Line: Schwab’s announcement closes an important chapter in the inevitable decline in trading costs. At the same time, “free trading” echoes similar trends prevalent more broadly in investing—including low-cost funds and financial advice. We believe these trends are here to stay, and successful wealth advisors will incorporate innovative developments with traditional, proven methods to help clients achieve their long-term goals.