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As upstarts offer free stock trading, big brokers shun price war

Michael Santoli
Michael Santoli

It sounds like the setup to every Web 2.0 business disruption story: Venture-capital fortified software upstarts start giving away a service for which the entrenched oligopoly hasn’t cut prices in years.

When it comes to a new spawn of zero-commission stock-brokerage players and the incumbent online brokers, though, the story’s not likely to play out in the typical way.

Not only are the big five web brokers comfortable continuing to charge $7-$10 per trade as part of their broad set of investment offerings, but would-be disruptors don’t really view the clients of the established firms as their kind of customer at all.

A new broker called Robinhood Financial is preparing to offer free stock trades with no minimum account size, and claims a waiting list of a half million to download the app, set to be available soon for the iPhone.

Another approach is being taken by Loyal3, which allows individuals to buy stocks of a broad but select list of companies commission-free, including buzzy IPOs such as GoPro Inc. (GPRO) and trendy airline Virgin America Inc. (VA).

The emergence of well-funded new entrants premised on no-cost trading points to the fact that the big five online brokers – Charles Schwab Corp. (SCHW), Fidelity Investments’ brokerage division, TD Ameritrade Holding Corp. (AMTD), E*Trade Financial Corp. (ETFC) and Scottrade Inc. – have held their “list price” on trades steady between about $7 and $10 since at least 2010.

A ‘commoditized’ service

This price stickiness runs counter to the trend in institutional stock trading, which has gotten dramatically cheaper in recent years.

And yet, the established giants, who collectively house nearly $5 trillion in client assets, are unworried about this new bout of price-cutting – a game that they all used to grow into a huge retail financial sector since the 1990s.

Rich Repetto, who covers the e-brokers for Sandler O’Neill + Partners, says the big brokers aren’t in a rush to collapse their prices. The most active traders already get discounts, for one thing. And ultra-low short-term interest rates have compressed an important revenue stream for them – the interest on the “float” in customer accounts – making them loath to forgo more commission revenue. Note that when interest rates crashed to zero, the brokers didn't lift commissions to offset lost income.

Executives at the large players emphasize a few additional points: Commissions at or under $10 are already quite low given the typical account size and trade frequency of their clients, and in light of the broad array of investment services that come with an account there.

Their clients want research, real-time customer service, good order execution, cash management, debit cards and all the rest, and most don’t trade enough – or trade in large enough amounts – that saving a few bucks per trade is not that important.

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Steve Quirk, senior vice president for TD Ameritrade’s trading division, says retail trading “is commoditized” among firms like his that have “an all-in model” of investment services.

“Commission levels have hit, let’s say, an equilibrium point and are not likely to go much lower,” Quirk adds. So the competition occurs over “who can offer more.”

Ram Subramaniam, president of Fidelity’s retail brokerage, which has $1.48 trillion in client assets, says offering more these days means 24/7 customer service, copious investment research and tools, a wide selection of zero-transaction-fee mutual funds to select from and even a credit card that offers 2% cash back.

He adds that at Fidelity, which makes markets in stocks and handles most customer orders, its research shows that the average savings on a 1,000-share market order is $7.44 off the quoted price when the order was entered, vastly better than the industry average of $1.23. That savings covers almost all of the $7.95 commission.

With an average trade size at or above $20,000, too, an $8 commission amounts to a pretty trivial percentage of the transaction value.

Quirk also notes that in a recent in-house survey, clients ranked quality of service and the “financial stability of the firm” as the most important variables in choosing a broker. Clients are, after all, often handing their college and retirement savings to these firms. “This is not a Groupon,” he says.

In other words, the large brokers view themselves as investment supermarkets offering a comprehensive financial relationship, not simply trades at the lowest possible price.

But does the big guys’ confidence in their market position leave the door open for the new entrants offering a deal that resonates with the next generation of budding investors?

Can Silicon Valley crack Wall Street?

Robinhood’s creation story is right out of the current Silicon Valley script mill: Two programmers who coded for institutional high-frequency traders wonder why individuals can’t benefit from the same ultra-cheap trading, win backing from Google Ventures and Andreessen Horowitz and build an elegant “mobile-first” interface to make it happen.

In typical Valley fashion, the plan is to attract lots of young, digital-only customers with a free version of something that’s already cheap, and hope to make the business math work down the road with premium add-ons.

“We don’t view Robinhood as a discount brokerage,” says Vladimir Tenev, one of the founders. “We’re in Silicon Valley. We believe this hasn’t been done before, with no minimum or trading commissions. We’re making the service accessible to millennials.”

You knew it was going to be all about the millennials, right? This vast cohort in their 20s and 30s, says Tenev, are insufficiently engaged in financial markets and need an easy, highly democratic way into the investing world.

So far the most successful companies to adapt investments to millennial habits and priorities are the so-called robo-advisors, such as Wealthfront and Betterment.

These companies have easy sign-up processes and ultra low-cost, set-it-and-forget-it portfolios based on empirical concepts of diversification and long-term asset allocation. Wealthfront is up to $1.5 billion in client assets, and Betterment has exceeded $1 billion, and claim millennials "get" that it's futile to try to beat the market and just want frictionless, efficient portfolios.

Even these firms are not guaranteed to be particularly profitable charging tiny fees near 0.25% of assets unless they reach enormous scale and/or partner with larger firms, as Betterment already has.

Robinhood – even if its interface and sign-up process is as blissfully easy as promised – has a tougher task. It will need to offer margin loans, license its technology platform for other applications or sell customers’ order flow the way many other retail brokers do. “It’s fine for us if we don’t monetize every single account,” Tenev says.

Unlike Wealthfront and Betterment, which preach the unassailable virtues of long-term, low-cost index investing, Robinhood is hoping younger people just getting involved in investing will do so through picking individual stocks.

Tenev says Robinhood is based on the notion that younger people will be “introduced to investing through companies they care about and brands they trust,” whose shares they will then buy. This might resonate with the young do-it-my-way crowd. But, of course, casually picking individual stocks based on personal affinity is a pretty good recipe for getting eaten up by the market.

Richard Hagen, president of TradeKing and a member of the Yahoo Finance Contributors Network, points out that the zero-commission gambit has been tried before, including in 2007 by Zecco.com (the name is drawn from “zero commission”). Hagen’s company later bought Zecco.

Hagen says integrating Zecco showed him “what worked and what didn’t work. It’s extremely challenging to build a business to rely on interest revenue from cash balances or margin loans."

TradeKing charges $4.95 a trade, and Hagen says, “I doubt anyone can go very much lower and make a credible go at it.”

He adds that 30% of his customers are millennials, who don’t seem to mind paying $4.95 – “the price of a latte.”