Earlier, it was announced that Charles Schwab is dropping all fees for its domestic brokerage trades executed through its online and app portal (that previously cost $4.95 per trade and before that, $8.95 per trade). Schwab indicated that the move was in response to apps and fintech startups like RobinHood that granted investors free trades. In its press release, Schwab called this move “an inevitability” due to the competitive pressures that it was facing.
From the business side, the price of Schwab stock fell 6% (and its peers ETrade and Ameritrade) fell much further for the obvious reason that cash-cow trading fees are being siphoned out of the industry’s business model.
In 2018, Schwab generated revenues of $10.1 billion, and $500 million of that was related to trading fees. So it’s about 5% of the company’s overall business. It was responsible for about $250 million of the company’s $3.9 million in profits, or a little over 6%. The way I think about it is that this move by Schwab gave away about a year of its growth in profits.
In exchange for this market-driven concession, Schwab has gained an enormous competitive advantage by thwarting rising fintech stock-trading apps. Many fintech companies, like Loyal3, started out free and then either started charging a fee or sold to an entity that does (i.e. FolioFirst). Now, the incentives for launching a brokerage house are greatly curtailed.
Schwab is effectively saying this to all-would be competitors: If someone can go to a great brokerage house, with a well-established reputation, where investor funds are SIPC protected in the amount of $500,000 and then there are Llloyds of London-issued insurance policies stacked on top of that, all for no cost, why would someone go to a startup where the service is the same but those additional benefits are not present?
Currently, Schwab has $3.25 trillion in assets under management. Approximately 3% of those assets are cash. With $97 billion sitting in cash, Schwab can earn 2% on client’s money (or approximately $1.9 billion) and then pay out 0.34% to clients ($329 million) so it can generate profits of approximately $1.5 billion. Schwab is a giant asset gatherer and the real money is made on the cash sitting in the Schwab accounts. By offering free trades, Schwab is cementing its ability to maintain its market position and even draw in new customers while also thwarting potential competition because you can’t beat free.
From a consumer perspective, this move is wonderful. We should appreciate the fact that the past few decades represent the only time in human history that stocks and bonds were available to the “common man” at a low cost. If you lived anywhere, anytime pre-1970s, stock investing was not feasibly available to the middle. You had to already be rich to access business ownership, leaving many in a position to reap the benefits of nothing in addition to their own labor as they progressed through life.
Now, with free trades, someone could commit to, say, buying a share of Berkshire Hathaway stock for around $200 every month and build up a 120 share position over the coming decade. When that stock trades over $600 in 2029, someone will have a $72,000 source of capital in 2029 that would be the product of minimal (yet continuous sacrifice). I have a special place in my heart for those who invest $500 to $3,000 every month because that is the type of continuous rate that can upgrade someone from middle-class to upper-class in a generation if the surplus is managed well. With Schwab now charging nothing, and frictional fees now at zero, the only thing to manage is your own discipline for investing and the underlying tax strategy. One of the three hurdles has been effectively vanquished.