Charles Schwab and TD Ameritrade announced moves Tuesday to eliminate commissions for stocks, exchange traded funds and options, including for the registered investment advisors who custody with the firms. The news sent the stock prices of online brokers plummeting.
Registered investment advisors agree the pricing war is a positive development for the industry and their clients, with a significant percentage indicating they would consider asking clients to move assets to Schwab (39%) and directing new client assets to Schwab (43%), in a flash poll conducted by WealthManagement.com. (News that TDA was eliminating commissions came late Tuesday, after the poll was already in the field.)
Despite a $1.5 million account minimum, Michael Kossman, chief operating officer and partner at Aspiriant in Los Angeles, which custodies primarily with Schwab, believes clients will notice the difference in price.
“$4.95 for a trade—nobody should care about, but they do,” Kossman said. “The optics are real. It’s human. ‘Oh my God, I get this for free now? I used to pay for this.’”
“I think it’s fantastic for our clients, and by extension, for us,” said Greg Friedman, CEO of Private Ocean in San Rafael, Calif., which also custodies with Schwab. “It lowers the overall cost to the client, and I think that’s great.”
But many advisors are skeptical of the moves, questioning how the firms are going to make up the revenue lost; there’s no free lunch, after all.
“This is a net positive,” said Allan Boomer, managing partner at Momentum Advisors in New York. “However, it always makes me wonder what's the catch. Schwab has made a lot of decisions that benefit shareholders at the expense of my clients. It is my job to protect them, so I am always looking for the catch.
“Service is another huge factor that advisors must consider. It just got cheaper to do business at Schwab, but advisors must ask if the firm just got any better. They recently announced layoffs, which may impact service. Also, they are doing a lot to re-shuffle their service teams and phone numbers; it's been a headache dealing with Schwab recently.”
Aaron Wealth Advisors CEO Gary Hirschberg questioned whether the custodians involved may institute a kind of threshold for the number of trades that could be made before a fee is introduced, saying that it could be economical for a custodian to introduce basis points to the conversation after a certain number of trades are completed.
“Does this change your threshold for when you need to charge a basis point fee, or start charging for transactions?” he said. “There’s got to be a breaking point somewhere for the organization, and that may be moving now that it’s shifted to zero costs.”
“A firm can’t just eliminate a major revenue source like that without replacing it somehow, so then the question is, how are they going to do that?” said Scott MacKillop, CEO of First Ascent Asset Management, a turnkey asset management platform in Denver. “And does that revenue replacement process create conflicts or problems that may emerge for the clients down the road?”
Forty-four percent of the nearly 200 RIAs who responded to WealthManagement.com’s poll said they were concerned clients would sacrifice best execution on trades because of increased back-end costs, i.e. selling order flow.
Schwab says the pricing reduction translates to about $90 to $100 million in quarterly revenue, or 3% to 4% of total net revenue. But it expects to make up the difference through organic asset growth as a result of the pricing move. (When Schwab announced a reduction in commission pricing in February 2017, it had $2.9 trillion in assets; it had $3.72 trillion as of the end of August.)
The firm will also rely on net interest revenue from the cash it holds in client accounts. It does not expect any immediate changes to its payment for order flow approach.
“All Schwab clients benefit from Schwab’s superior execution quality and price improvement, and will continue to after this change,” spokeswoman Mayura Hooper said.
TD Ameritrade CFO Steve Boyle said he expects a revenue impact of $220 million to $240 million per quarter, or 15% to 16% of net revenue. Last year, the firm made more than 25% of its revenue from commissions, backing out payment for order flow, according to a Jefferies analyst note.
Spokesman Joseph Giannone declined to comment further.
“I’m not positive that it’s a great thing for investors to have these brokerage/clearing firms more dependent on opaque revenue flows from order flow,” said Aaron Klein, CEO of Riskalyze in Auburn, Calif. “In theory, you may be saving $7 on a trade, but for thousands and thousands of shares, you may be paying way more than $7 for your actual shares.”
Klein said it’s a nontransparent, opaque process, and not even the brokerages know whether investors are being disadvantaged or not. There are rumblings the SEC is looking into issues around order flow, although the agency has not come out with anything explicit, he added. An SEC spokeswoman declined to comment.
“Advisors are going to pay very close attention to this because they want to make sure that they’re getting best execution for their clients,” Klein said.
Todd Petzel, chief investment officer at Offit Capital, said the issue bears watching, but that the news does not materially change the situation.
Charles E. Helme, managing director of BH Asset Management in New York, said the worst executions are with the wirehouses and securities subsidiaries of regional banks. “It’s hard to believe Schwab would prejudice their lead offering with poor execution performance.”
Aspiriant's Kossman, who assesses execution once a year, said execution is pretty indistinguishable from broker to broker.
But he’s skeptical of relying more on cash accounts for revenue, which can be nontransparent.
“We don’t like it when things become non-transparent, like is done sometimes with how cash is handled,” he said.
Brokerage firms typically place the cash portion of a client’s portfolio into a so-called “sweep” account, usually with an affiliated bank, that earns the client very little, with yields hovering around 0.04% to 0.13% at the major brokerages for small amounts of cash. (Fidelity recently highlighted its long-standing policy of automatically placing excess client cash in retail brokerage and retirement accounts into its government money market fund, comparing the yields earned there to the default sweep accounts at other brokerages. Schwab pays 0.18% in their cash sweep account for amounts under $1 million, while TD Ameritrade’s default swap yields anywhere from 0.04% to 0.43%.)
“Schwab is very adept at padding its pockets in various ways,” Momentum Advisors' Boomer said. “One way is the decision they made to eliminate money market funds as a default cash option for clients in favor of their bank deposit products. These bank deposits offer a yield to clients that is a fraction of the yield offered by money market funds, which are also more diversified in terms of credit risk. This cash decision was an example of what's wrong with brokerage firms—they exist to make a profit, even if it's at the expense of what's best for their clients. This is why the RIA industry and its fiduciary standard exists—to help clients make the best decisions that benefit them and not the brokerage firms.”
Nearly 57% of RIAs who responded to the poll said they would pass the savings on to their clients.
“A large percentage of my clients are small business owners or executives, and knowing my clients they would first feel it was good news,” said Charles Parks, president and CEO of CF Parks Wealth Management in Salisbury, N.C. “However they would quickly pivot and ask ‘Where’s the beef?'—meaning, ‘I must be paying this cost somewhere, and where is it coming from?’ So in the end it could be harder to explain going to zero than going to a lower figure than they currently charge. And it would not make me more likely to move assets there until I could get much more of an in-depth explanation.”
Peter Raimondi, CEO and founder of Dakota Wealth Management, said he believed investors and advisors may turn their eye toward products with unnecessary commissions, such as load mutual funds. Investors may start to question why such a product exists.
“I think the next shoe to drop could be the unnecessary expenses and charges on mutual funds and other investment products, such as annuities. That’s really where the pressure is; the client’s paying 2-4% of their investment on an upfront load or commission, and I think that’s where you get some issues,” he said. “There’s no place else to go; everything else is free to trade and execute. When you’re talking about the retail consumer, what was a somewhat insignificant charge is now zero."