from the Provident Investment Management blog
Old-fashioned stockbrokers called it May Day: May 1st, 1975. That’s the day the Securities and Exchange Commission allowed brokers to deviate from the old fixed-commission schedule. Prior to that date, all brokerage firms charged the same price for processing a stock trade. And with pricing under the control of a cartel (the New York Stock Exchange), of course it wasn’t exactly cheap! On May Day, enterprising Charles Schwab began discounting commissions. Now, 44 years later, commissions have fallen all the way to zero. I’m sure that would have been utterly unimaginable in 1975, but then again so would much of what we take for granted today.
I looked back at our own trading records to remind me how far we’ve come. When I joined Provident in the early 1990s, trading costs were 25-75 cents a share, subject to a minimum commission. For example, trading 700 shares cost $196 or 28 cents a share. Most of our trades were executed by a large brokerage firm that provided research and other information, mostly of dubious value. Looking to do better for our clients, we took an educated gamble and moved to a new breed of execution-only institutional brokers that didn’t bundle research services with high-cost trading. Within just a few years, client commissions had fallen to a nickel a share! Trading 700 shares cost $35, down 80% in just a few years, and we thought we were in heaven.
Costs continued to fall, becoming a flat $25 in the late 1990s and declining in stages until reaching $7.95 in 2005. That was another 80% decline from our $35 commission in about a decade. How could they possibly decline any further? How could the brokerages possibly make money?
Astonishingly, they dropped further: in 2017 Fidelity dropped commissions to $4.95 for clients with at least $500,000 in household assets and for all clients willing to have account statements and trade confirmations delivered electronically.
How could that be possible? Someone is willing to do something for me for no compensation? And they do it voluntarily?
Well, yes and no. The rush to zero was initiated in late September by Interactive Brokers, a firm dedicated to active traders. They make money on bid-ask spreads, margin balances, and then on fees for “lending” customer securities to institutional traders, typically short-sellers. When someone wants to borrow against their shares, the shares are first placed into “type 2” (margin), which automatically makes them eligible to be lent out. Interactive Brokers keeps some or all of the lending fee.
Schwab was the next one to go to zero in early October. It could afford to do this since stock trading commissions were only 7% of its revenue. It makes much more by stashing customer cash balances in its own Charles Schwab Bank accounts, recently paying 0.23% compared to the 1.7% offered by Fidelity money market funds. “Free” is rarely without cost.
Rival brokerage firms immediately followed suit. Fidelity was slower in responding, one of the luxuries of being a privately-owned company. Effective November 4th, Fidelity will join the zero-commission club.
Like with the other firms, however, there are some terms. Households whose accounts total $1 million or more, excluding corporate accounts, will automatically qualify for zero commissions. Households under $1 million in total assets need to sign up for electronic statements and trade confirmations to obtain commission-free trading. We are working with Fidelity to determine who is not currently eligible for free trades and will contact those clients.
Fidelity makes money managing its own money market funds, on bid-ask spreads when trading stocks, on margin interest when clients borrow against their securities, and from securities lending fees. The latter two sources of income for Fidelity are completely voluntary and very rare in the case of Provident clients.
It didn’t occur to me 27 years ago that it was even possible for commissions to go to zero. Therein lies the beauty of the free market: creating win-win situations where enterprising businesses can take market share while offering the consumer better features and/or lower prices.