Schwab Wins The Race To Zero: How Full-Service Full-Commission Brokers Can Thrive

The only ways to compete with “free” are superior scale and superior service. The landscape actually looks better now for small boutique firms.

For decades, stockbrokers and asset managers have learned to work in the shadow of commodity math and its inherent cruelty. Now Schwab has turned the lights all the way down.

The firm’s clients trade all the U.S. stocks they want for free. It’s a transparent grab for assets. 

And it’s a proposition that no competitor can beat. Anyone else who counted on making money on execution now needs to justify why they’re charging.

They’re welcome to match the offer of course, racing with Schwab to zero. But short of actively giving money away, they’re never going to do more than keep up on pricing.

This is Schwab’s game to win now. They’re welcome to it.

Playing chess on the checkerboard

We saw something similar play out in the original discount brokerage boom. Schwab led the way then, too. 

The strategy was simple. Cut out all the services and the elegance and you can provide execution to people who would otherwise not be able to afford it at all.

Trading costs were low because Schwab and its counterparts kept overhead under control. The offices weren’t fancy and soon call centers and online support took over.

As long as commissions were above zero, everyone was making money and the business flourished. The people who suffered were the ones with frills clients didn’t really appreciate after all.

Their cost structures were lavish to match their markets. They survive now in niches like private banking and full-service wealth planning.

But the industry the discount brokers transformed was really only going through a transition from rarefied service to large-scale commodity. The service model bent under fee compression. Here at zero, it’s busted.

Schwab doesn’t mind. After decades of prying assets away from higher-priced competitors, they’re definitely one of the big gorillas now.

Admittedly, the $3.7 trillion on the platform now barely generates $600 million in commissions a year. Even pushing clients to in-house funds is only worth another $2 billion at best.

The real money is on the cash sweep on client accounts and securities lending. Incremental interest on those floats generates $8 billion a year.

The math is simple. Once zeroing commissions attracts $270 billion from rival brokerage firms, Schwab won’t feel any pain at all.

And as more of that money flows into proprietary funds, net margins improve. Anyone who complains at that point can simply get a referral to the advisor network.

Either way, Schwab won’t mourn the decision to give away what was once the heart of the business for free.

Its smaller and more commission-driven competitors aren’t so lucky. If they try to compete on price (zero) without a new revenue engine ready to kick in, they’re in trouble.

Raymond James remains relatively serene upstream. Commissions don’t even drive 20% of the top line there these days. Management fees are already the center of gravity.

E*Trade is in a slightly more precarious position. If it cuts trading costs to zero, what’s left behind is 80% interest. The company becomes a prisoner of rate policy. 

There’s $600 billion in client assets there to capture or defend. The executives there are going to get desperate for ways to add value.

Maybe they’ll want to team up with full-service advisors in order to give customers an experience differentiated on something besides cost.

They might even buy an advisory group in an effort to jump upstream and out of the commodity pool.

And then there’s TD Ameritrade, where $1.3 trillion in client assets generate $2 billion in annual commissions, or about 35% of overall revenue.

They can’t give up that cash flow without something to replace it. 

Adding value and managing “wealth”

Of course Schwab is only graduating into the world of true giants where commodity price pressure is equally intense.

Charging 0.07% on ETFs adds up to real money when you run trillions across that near-zero drag. But at zero, it doesn’t matter.

Right now, the race to zero on the asset management side has created vast empires like Vanguard, Fidelity and BlackRock as funds with higher fee structures bleed accounts.

Those funds just can’t justify their fees unless they can communicate some kind of value add. Maybe that’s better performance under certain well-defined conditions. Maybe it’s something else.

They aren’t outperforming, so as the Bogleheads say, there’s no reason to pay higher fees for returns that at best match the index funds.

And until they can come up with some new “killer app,” they’ll keep bleeding while the near-zero-fee complexes swell.

Like Schwab, the giants make their money on the float, loaning securities from their massive balance sheets and collecting incremental interest between trades.

They manage trillions of dollars of anonymous assets. (I couldn’t help but notice that Vanguard turned my fund account into a full brokerage relationship recently, by the way. They want to kill the brokers too.)

Do you manage anonymous assets or do you manage wealth for individuals? That’s the difference. That’s how you outrun the robots, the equivalent of the “discount brokers” of a previous generation.

They’re inevitably going to drive the retail cost of pure allocation to zero or too close to it to sustain professional standards of living. 

That’s not your business. Whether you charge commissions or all-in-one fees, you’re not a commodity player. 

Of course if you want to compete on that basis, you’re going to need to start putting together a few trillion dollars fast. I suspect that’s not the way you operate.

That’s the world Schwab always wanted. That’s where they live now.

For the rest of us, relationships are worth money. People respond to service. The full-service brokers didn’t die out immediately in 1975. Some are still thriving.


More Articles