Mental Models discussed in this podcast:
- 2nd-order effects
- Price Competition
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You can find out more information by listening to episode 11 of this podcast.
Show Outline: Broker Price Wars
The full show notes for this episode are available at https://www.diyinvesting.org/Episode46
Major Online Brokers eliminated commissions on Stock Trades:
- Interactive Brokers (IBKR) – On September 26th announced IBKR Lite, with unlimited free trades on United States exchange-listed stocks and ETFs.
- Charles Schwab (SCHW) – Effective October 7th, Schwab eliminated commissions for stocks, ETFs, and options on U.S. and Canadian exchanges.
- TD Ameritrade (AMTD) – Effective October 3rd, TD Ameritrade eliminated commissions for stocks, ETFs, and options on U.S. and Canadian exchanges.
- E-Trade (ETFC) – Effective October 7th, E-Trade eliminated retail commissions on U.S. listed stock, ETF, and option trades.
- Fidelity (Private) – Effective October 10th, Fidelity eliminated retail commissions on U.S. listed stock, ETF, and option trades. [Not announced prior to the recording]
Robinhood: The beginning of the end
- Popular with young investors (Millenials)
- Free trading – announced in 2013 as a startup
- Receives payments for order flow
2nd-order effects
- The potential demise of the paid index fund
- Why pay a non-zero management fee, when you can replicate the entire index for free?
- Fidelity has already shown this with zero-fee index funds.
- Higher returns for investors all-else equal
- If you don’t change your trading behavior, your returns should rise with this change. You have lower expenses but the same gross return. Your net return should be higher.
- Changing behavior that promotes more frequent trading. (Could be a major negative)
- Changing behavior that increases the number of investors and the amount they invest
- Leading to lower returns in the aggregate as more money chases the same number of assets.
How do brokers make money?
- Robinhood makes money through order flow
- Brokers also earn money through:
- Spread between cash interest paid and earned by the broker to investors
- Internal ETFs and Mutual Funds
- Asset Management Fees
Summary
The end game has begun in the brokerage price wars. We have reached the zero bound in terms of commissions now at $0 for US and Canadian exchanges. This will have a major impact on the accessibility of investing and will certainly change the recommendations I have made in the past to new investors.
