How do free brokers make money?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
the_wiki
Posts: 2882
Joined: Thu Jul 28, 2022 11:14 am

How do free brokers make money?

Post by the_wiki »

20 years ago when online investing was in the early days, it was obvious how brokers made money. I paid $10 or so per trade, and mutual funds could be $50 if you weren't buying them direct. There were account maintenance fees, and transfer fees and all that.

Now, I look at my free broker account, with free stock trades and free transfers and free mutual fund purchases and I can't figure out where they make money.

Where are they getting their cut?
Marseille07
Posts: 16054
Joined: Fri Nov 06, 2020 12:41 pm

Re: How do free brokers make money?

Post by Marseille07 »

Selling your order flow to Citadel so they can front-run your trade. Not an issue for Bogleheads. https://www.investopedia.com/terms/p/pa ... erflow.asp
invest2bfree
Posts: 1279
Joined: Sun Jan 12, 2020 8:44 am

Re: How do free brokers make money?

Post by invest2bfree »

the_wiki wrote: Thu Aug 11, 2022 5:11 pm 20 years ago when online investing was in the early days, it was obvious how brokers made money. I paid $10 or so per trade, and mutual funds could be $50 if you weren't buying them direct. There were account maintenance fees, and transfer fees and all that.

Now, I look at my free broker account, with free stock trades and free transfers and free mutual fund purchases and I can't figure out where they make money.

Where are they getting their cut?
Also they lend out your cash on your accounts.
36% (IRA) - Individual LT Corporate Bonds , 33%(taxable) - schy, 33%(taxable) - SCHD Dividend Growth
exodusNH
Posts: 10347
Joined: Wed Jan 06, 2021 7:21 pm

Re: How do free brokers make money?

Post by exodusNH »

the_wiki wrote: Thu Aug 11, 2022 5:11 pm 20 years ago when online investing was in the early days, it was obvious how brokers made money. I paid $10 or so per trade, and mutual funds could be $50 if you weren't buying them direct. There were account maintenance fees, and transfer fees and all that.

Now, I look at my free broker account, with free stock trades and free transfers and free mutual fund purchases and I can't figure out where they make money.

Where are they getting their cut?
Interest on settlement funds
Some use payment for order flow
Others hope that some of the free users will pay for advisory services
Some brokers, like Fidelity and Schwab, have their own funds and get paid via part of the funds' expense ratios
Lending securities
Margin loans
Commissions on more advanced financial products like options
afan
Posts: 8193
Joined: Sun Jul 25, 2010 4:01 pm

Re: How do free brokers make money?

Post by afan »

When commissions went to zero it was a problem for some brokers that relied on them for substantial fractions of their revenue. Others already were milking the other sources and gave up little to make the switch.

As a retail investor in the BH mode, you can go to a broker that does not do PFOF and has no commissions. They will do the same things for you as a broker that collects PFOF. If you also keep your cash invested somewhere, rather than sitting at near zero interest in the brokerage account, you get the best of those worlds and they really do not make much on you.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
dharrythomas
Posts: 1223
Joined: Tue Jun 19, 2007 4:46 pm

Re: How do free brokers make money?

Post by dharrythomas »

I believe that some firms make money on the bid-ask spread. You can rest assured that they are making money and it is either coming out as a fee (to you or somebody else), higher prices for securities or they are keeping part of the profit earned on your account. I’m also confident that PFOF has an impact on prices that is of benefit to the Hedge Fund and the detriment of the small investor, otherwise I’m pretty sure they wouldn’t be paying for it. There is always a catch.

I’ve heard it said that “If you’re not the customer, you’re the product.” Which is similar to “If you’re not at the table, you’re on the menu!”
gougou
Posts: 1317
Joined: Thu Sep 28, 2017 7:42 pm

Re: How do free brokers make money?

Post by gougou »

How Does ETrade Make Money:
https://entrepreneur-360.com/how-does-e ... oney-16158

ETrade’s largest source of revenue is making money through their interest earning assets, which make up roughly 64% of ETrade’s total net revenue.
The sillier the market’s behavior, the greater the opportunity for the business like investor.
User avatar
jeffyscott
Posts: 13486
Joined: Tue Feb 27, 2007 8:12 am

Re: How do free brokers make money?

Post by jeffyscott »

And, similarly, How does Charles Schwab make money?
56% of Charles Schwab’s total revenue comes from Interest.
https://entrepreneur-360.com/how-does-c ... oney-16155

#2 for Schwab is Asset Management And Administration Fees, 30%.

But how does Vanguard make money? The "owners" would like to know.
I don't think it's net interest. They seem to trying desperately to boost asset management fees via PAS, based on them shoving a giant ad for it in my face every time I log on. They also are offloading costs to other brokerages, with 90% of their ETF's assets apparently being held somewhere other than at Vanguard.
pseudoiterative
Posts: 575
Joined: Tue Sep 24, 2019 6:11 am
Location: australia

Re: How do free brokers make money?

Post by pseudoiterative »

gougou wrote: Thu Aug 11, 2022 6:01 pm ETrade’s largest source of revenue is making money through their interest earning assets, which make up roughly 64% of ETrade’s total net revenue.
Bit of a tangent to free brokers:

I was once looking for individual stocks to invest in -- yes, how very non-bogleheadish, bear with me -- and identified a tiny public financial company which looked unusually profitable. I read through the annual reports, attempting to understand the business model. Where did those unusually high profits come from?

Their business was offering a few services around managing niche kind of trusts or accounts to hold shares in private companies, etc, on behalf of their clients. Here's where essentially all of this business' revenue and profit came from:

1. client opens some kind of niche trust account with the company, transfers in their assets, transfer in some unlisted stock, maybe some cash etc
2. company gathers up all their client's cash balances, invests the cash in risk-free bonds, collects interest
3. company doesn't pay any of the interest to clients, it keeps it as revenue.
4. cash balances in the clients accounts erode away over the years from inflation and no interest

Disgustingly profitable. They didn't appear to do anything else that could actually produce revenue. Pretty eye opening.
Gaston
Posts: 1220
Joined: Wed Aug 21, 2013 7:12 pm

Re: How do free brokers make money?

Post by Gaston »

jeffyscott wrote: Fri Aug 12, 2022 8:24 am But how does Vanguard make money?
In episode 37 of the Bogleheads On Investing podcast, Vanguard exec’s talked about the Vanguard Total Market Index fund, which has over $1 trillion in assets across all its share classes. They said that from this one fund alone, Vanguard earns about $170 million per year from securities lending.

They also said that for the ETF share class, about 10% is held at Vanguard and 90% at other brokerages. So yes, if investors hold Vanguard ETF’s at other brokerages, it helps Vanguard reduce its own fund expenses.
“My opinions are just that - opinions.”
User avatar
jeffyscott
Posts: 13486
Joined: Tue Feb 27, 2007 8:12 am

Re: How do free brokers make money?

Post by jeffyscott »

Gaston wrote: Sat Aug 13, 2022 10:21 am
jeffyscott wrote: Fri Aug 12, 2022 8:24 am But how does Vanguard make money?
In episode 37 of the Bogleheads On Investing podcast, Vanguard exec’s talked about the Vanguard Total Market Index fund, which has over $1 trillion in assets across all its share classes. They said that from this one fund alone, Vanguard earns about $170 million per year from securities lending.

They also said that for the ETF share class, about 10% is held at Vanguard and 90% at other brokerages. So yes, if investors hold Vanguard ETF’s at other brokerages, it helps Vanguard reduce its own fund expenses.
But how does Vanguard Brokerage make money?

My understanding is that money earned from securities lending goes only to Vanguard fund shareholders.

The second item is offloading costs to other brokerages, which I had mentioned. While that reduces costs for Vanguard's brokerage, it would not seem to explain how Vanguard's own brokerage makes any money, unless Vanguard ETFs are subsidizing Vanguard brokerage operations.

My understanding is that Vanguard funds (and this includes ETFs as well as mutual funds) pay nothing to Schwab or Fidelity for assets that are held at their brokerages. Do you think that these same funds pay for Vanguard's brokerage operations, whether or not the assets are even held there?
Gaston
Posts: 1220
Joined: Wed Aug 21, 2013 7:12 pm

Re: How do free brokers make money?

Post by Gaston »

jeffyscott wrote: Sat Aug 13, 2022 11:41 am But how does Vanguard Brokerage make money?
My guess is via a combination of many of the same items that exodusNH mentioned earlier in this thread.

For example, for all the people who purchase individual company shares via Vanguard brokerage, Vanguard acts as custodian for those shares. So it can earn income from lending those shares.

Another guess: If Vanguard’s operating costs (staff, office space, computer systems, etc) are roughly equal to those of Fidelity or Schwab, then Vanguard need not earn as much income because Vanguard, unlike Fidelity and Schwab, need not earn a profit on its operations.
“My opinions are just that - opinions.”
Post Reply