Fidelity just became the fifth major broker to drop stock trading commissions in the past couple of weeks, joining some of the industry's other large players in making online trades free. This trend has been a major win for stock investors, particularly younger and beginning investors who tend to make smaller purchases.
Here's why $0 has become the new standard commission in the online brokerage world, and why the move won't have as big an impact on the bottom lines of Fidelity and the others as you might think.
The latest in a string of commission-slashing
Fidelity's move to get rid of trading commissions was likely made out of necessity. After several competitors did away with stock trading commissions, Fidelity would have risked losing customers if it continued to charge $4.95 for trades.
Interactive Brokers (NASDAQ:IBKR) announced in late September that it was creating a commission-free trading platform, but this has generally been a low-cost niche platform for active investors, so it didn't exactly send shock waves through the investment community.
But when Charles Schwab (NYSE:SCHW) announced that it was slashing its stock trading commissions from $4.95 to $0 on Oct. 1, it caught the entire financial industry off-guard. No-frills platforms like Robinhood and niche players like Interactive Brokers offering free stock trades was one thing -- a feature-packed platform that's one of the largest brokers in the industry was another story altogether.
Fees and commissions in the financial industry have been gravitating toward zero for some time. Most of the major brokers have already reduced their commissions significantly in recent years, and disruption from Robinhood and other fintech start-ups has been pressuring the industry. It was only a matter of time before the bigger players responded.
Won't this cost Fidelity most of its revenue?
At first glance, it may seem like this move will destroy the profits of Fidelity and the other brokers that now offer free stock trades. In Fidelity's case, the company also announced that it won't be paid for order flow based on where it sends its trades as well -- a way that some other $0 commission brokerages generate revenue.
In reality, however, Fidelity's revenue hit is likely to be quite minimal.
Brokers have other ways of making money than trading commissions. For example, they get fee income from their proprietary investment products like robo-advisory services, mutual funds, and more. They collect some interest income from the funds they hold in custody. In fact, after considering the other revenue sources, commissions are generally a relatively small portion of revenue.
For example, TD Ameritrade generated just one-fourth of its revenue from trading commissions in the most recent quarter. For Schwab, the percentage was even lower at just 7%. Because Fidelity has a diverse array of financial products (although it is private and we have less knowledge of its revenue structure), it's likely that it is on the lower end of the spectrum in terms of commission revenue as a percentage of its total.
The bottom line is that the industrywide move to $0 commissions isn't exactly a surprise, although the quickness of the move surprised many investors. From a long-term perspective, this was not only necessary for Fidelity, but it could also be a net positive since it could see an influx of assets from investors who had previously been using a no-frills platform to save money but who would benefit from the features and superior platform Fidelity offers.