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Shockwave Hits Brokerage Firms After Charles Schwab Slashes Commissions

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Charles Schwab (SCHW - Free Report) sent a shockwave through the investment bank industry after it announced that they would be slashing their commission fees to zero. The investment firm announced on Tuesday that starting October 7th, they will be eliminating their trading commission fees for US stocks, ETFs, and options.

Charles Schwab shares closed down 9.73%, TD Ameritrade (AMTD - Free Report) closed in the red by a whopping 25.83% for its worst day in 13 years, and E-Trade (ETFC - Free Report) ended their day down over 16%. Founder and chairman, Charles Schwab, commented in a press release that the firm’s “passion has been to make investing easier and more affordable for everyone” after the announcement. 

Why Cut?

The equity and fund trading landscape has changed substantially in recent years after the Silicon Valley startup, Robinhood, offered free stock trading back in 2013. Many investors were stoked at the opportunity to trade equities freely without having to account for trading commission costs. Charles Schwab’s decision to eliminate commissions comes after their competitor, Interactive Brokers (IBKR - Free Report) , announced last Thursday that their new product called IBKR Lite would allow users to trade US stocks and ETFs commission-free.

Founded in 2012, Robinhood has garnered around 6 million users, many of them millennials, with its smartphone app that allows users to buy and sell stocks without fees. A Robinhood spokesman stated “the changes taking place across the brokerage industry reflect a focus on the customer that’s been inherent to Robinhood since the beginning.” How do brokerages like Robinhood make money? They rely heavily on a practice called “payment for order flow” in which they route customers looking to buy or sell equities to electronic trading firms like Citadel Securities and Virtu Financial (VIRT - Free Report) .

The evolving trading landscape has led financial giants like JPMorgan (JPM - Free Report) to play along. The banking giant announced their You Invest product last year that was aimed at younger, first-time traders and offered customers at least 100 free stock or ETF trades a year. Charles Schwab CFO Peter Crawford said in a note on the company’s website that “It has seemed inevitable that commissions would head towards zero, so why wait?”

Moving Forward

Brokerage firms have already been hurting this year because of falling stock-trading volumes as concerns over slowed economic growth have run rampant throughout the market. The interest rate cuts dealt by the Federal Reserve in their July and September meetings have also hurt brokerages by cutting into their ability to collect interest on clients’ cash. Wells Fargo (WFC - Free Report) analysts expressed concern about the brokerage industry, stating, “We were hoping the challenging macro environment would prevent the industry from competing on price like this, but that is clearly not what is happening.”

Charles Schwab may be better positioned to weather the storm as it is more reliant on their banking arm and less dependent on commissions. Commission fees make up about 7% of total revenue for Charles Schwab while commission fees contribute about a quarter of TD Ameritrade’s total revenue and roughly 20% of E-Trade’s net sales. The last time Charles Schwab lowered its commission fee was in February 2017, and assets under management grew from $2.92 trillion to the current $3.72 trillion. Time will tell which financial service companies can successfully adapt to the contemporary trading landscape, especially as millennials grow older and possess more purchasing power.

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