Interactive Brokers Group (IBKR 2.95%) has always been one of the lowest-cost electronic brokers in the industry, and now it's taking that to its logical conclusion.
The company just introduced a website called IBKR Lite that will offer customers commission-free trades and permits investing with no minimums or inactivity fees, beginning this month. Incidentally, a few days after IBKR's announcement, national broker Charles Schwab (SCHW 0.99%) followed suit, saying it will be ending commissions on U.S. stocks, ETFs, and options trading.
The move highlights just how competitive the electronic trading business is and how much investing has changed over the last decade. Some newer upstart rivals like Robinhood have been offering free online trades on stocks, ETFs, options, and cryptocurrencies for several years now. But Interactive Brokers is the first major brokerage to offer a free trading platform and highlights that the industry may have better ways to make money than charging commissions. Now, it appears the entire industry may be following this trend.
What customers will get
IBKR Lite will give customers "unlimited, commission-free trading on U.S. exchange-listed stocks and ETFs," access to global markets, and reasonable interest rate growth on cash held in the account. That's all without minimums or inactivity fees.
The interest rate on cash is advertised as 1.5% below the federal funds rate with margin borrowing rates of 2.5% above the fed funds rate.
The IBKR Lite platform will include a "Client Portal" that can be accessed online as well as the IBKR Mobile app that allows investors to trade on the go.
Put together, this is a cheap and easy way to start investing or to grow a portfolio. And it should attract more customers to the Interactive Brokers platform. But will it make the company more money?
How Interactive Brokers will make money
Don't think that Interactive Brokers' business will suffer too much from this move. The company has always had lower fees than traditional brokerages and hopes that free trades will encourage customers to trade more. From there it has multiple ways to make money.
The first profit center is from the spread between what investors pay and what they get from cash in their account. As it's advertised, Interactive Brokers is going to get a 4% spread between what it borrows customer cash for and what it pays as interest to other customers.
Brokers can also charge customers for shorting stocks that are highly shorted. Investors need to borrow stock in order to sell it short, and if there's a high percentage of shares sold short, brokers can demand to be paid for shorting a stock. This generates revenue and effectively limits how much of a stock can be sold short.
Another revenue generator for brokers is providing liquidity to exchanges. Stock exchanges will pay brokerages, or market makers, for providing liquidity so that retail investors have someone to trade with (on the buy- or sell-side).
There will also be revenue-generating products like international trading, bonds, options, and more exotic products.
Will free trading spur Interactive Brokers' growth?
The move to offer free trading is coming partly because Interactive Brokers is seeing some stagnation in its standard brokerage. Last quarter, revenue was down 7.2% to $413 million and a 10% drop in trading commissions was a big reason why. Free trading is also a competitive pressure, as we saw with Charles Schwab's announcement Tuesday.
Interactive Brokers could be seeing an opportunity to grow non-commission revenue sources outlined above if it attracts more customers. But to grow the customer base, it needs a hook, and free trading might be it.
At the end of the day, this could be a win-win for investors and brokerages that have a low-cost structure. Interactive Brokers isn't the first to test the free trading waters, but it is the first major brokerage to offer a free product and that may help increase the company's profile and attract a broader range of customers. That's the hope, anyway.