It may be hard to believe today, but a half-century ago, retail investors who wanted to buy or sell a stock would likely have had to pay Wall Street brokerage firms a few hundred bucks for the privilege.
That changed on May 1, 1975, when the Securities and Exchange Commission abolished the practice of fixed-rate commissions, a staple of stock trading for 183 years. Upstarts like Charles Schwab quickly disrupted the brokerage industry by offering commission fees at the bargain price of $70 a trade. The rise of online brokerages lowered discount fees further to about $14.95 per trade in the 1990s and, more recently, to around $4.95 per trade.
This week, Schwab is once again at the epicenter of a big change in trading fees. On Tuesday, the company dropped commissions for stocks, ETFs, and options on U.S. and Canadian exchanges. Within a day, TD Ameritrade and E*Trade followed suit with their own announcements of 0% commissions.
Schwab, of course, wasn’t the first to offer commission-free trading. Interactive Brokers introduced a zero-commission service last week. Vanguard offered free online trades for many of its funds last year, followed quickly by Fidelity. Around that time, J.P. Morgan Chase also created a service offering 100 free online trades per year. Now, Schwab’s move is serving as a tipping point that could make zero commission trades the norm.
But if Schwab is a key driving force, the true innovator in this area was Robinhood. Back in March 2015, Robinhood publicly launched an app targeted at millennials, which allowed for quick trading with no commissions. The startup generated revenue from parking idle dollars in user accounts in interest-bearing money-market accounts. It’s now working on rolling out banking accounts.
If past is prologue, the end of fixed-rate commissions in 1975 offers a guide of how free stock trades may shake out for online brokerages. In the following year, the SEC reported that commissions fell 30% for institutions and 6% for retail investors. A new breed of discount brokers like Schwab began to thrive. But the landscape was altered as some less nimble brokerages merged, were bought out, or closed up shop in the following years.
Because some brokerages have seen the writing on the wall this time, they have prepared in advance. Schwab, for example, has branched into other areas such as asset management and subscription-based services, and the bulk of its revenue comes from interest-earning assets. In its most recent quarter, Schwab’s revenue from commissions fell 1% year-on-year to $155 million, or about 5% of its total revenue.
The impact could be greater on e*Trade and Ameritrade. One analyst estimated the two companies’ annual earnings could fall by 22%. Ameritrade warned Tuesday that commission-free trading could reduce its overall revenue by between $220 million and $240 million, or 15%.
“It could take a long time for TD Ameritrade and probably E*Trade to fill in the hole in earnings left by pricing actions,” said Michael Wong, director of equity research at Morningstar. “Schwab is in a relatively better position, but still faces the likely headwinds from lower interest rates and potential decrease in the stock market.”
For now, investors are responding to the news with more than a sense of caution. Schwab’s stock has fallen 13% in the past two days, while Ameritrade’s has declined 28% and e*Trade’s is down 19%. Shares of Interactive Brokers are down 9% since announcing its no-commission service last week. Robinhood, which raised $323 million in July, remains a private company as it watches its innovation sweep the brokerage industry.
Traditionally, in markets where prices are falling, let alone vanishing, it’s the smaller players that are either acquired or merged together. Talk about an Ameritrade-e*Trade alliance has circulated for some time. Robinhood’s appeal to younger generations may also appeal to a larger, deep-pocketed brokerage, should its private backers be inclined to sell.
If commission-dependent brokerages have trouble adapting to an era where stock and ETF commissions are relics of history, it could leave the same financial upstarts who once disrupted the brokerage industry in the same dicey spot that the full-service brokerages were in a half century ago.