How Do Brokers Make Money?
The eye-watering revenues of stockbrokers may make many investors wonder how they make their money. For example, Charles Schwab is the world’s largest broker, with $7.6 trillion in assets under management, with countless other brokers also racking up the millions.
Truthfully, it depends on the broker. Figuring out how brokers make money is not always straightforward because they all have a different business model.
Let’s examine the various ways in which a broker might make money from its clients.
The Traditional Business Model
Traditional brokers, such as Charles Schwab, make money through levying fees and commissions on every action taken by their clients.
Want to buy some stocks? Pay up. Want to sell some stocks? Pay up. Want active management services? Pay up.
Management fees, trading fees, and commissions are part of how brokerages generate money from their clients.
Previously, every brokerage in the world operated using the same model, with only a few micro-percentages of difference.
To bolster their take and extract a minimum value from each client, they enforce minimum investment amounts. Typically, clients would need to invest a few thousand dollars with a brokerage to get started.
But times have changed…
Why Brokerage Business Models are Changing
How brokerages make money today has changed. Clients have become sick of paying excessive fees for every function on their accounts. Many have rightly asked what they are paying for in the first place.
The fact that just one in four active managers on Wall Street beat the market in 2021 has convinced many that there’s little value in hiring a so-called expert to manage their portfolios.
Although one in four may not sound horrific, this figure comes from just a single year. Stretch out the performance of the average fund manager over a ten and twenty-year period, and it soon becomes apparent that they perform little better than the average person.
Another reason brokerages have been forced to alter their business models is accessibility. Working Americans have long viewed owning stock as a wayward dream, something only the rich could hope to achieve.
Nearly half of all U.S. households own no stocks, and these are disproportionately black and other minority households. It shows that America’s bottom 50% have been locked out of investing in their futures.
The new generation of brokers have spotted this flaw in the market and have looked to capitalize.
The New Generation of Brokers
Ask, “How do stockbrokers make money?” today, and you’ll see the classic model has changed. In our M1 Finance review, we highlighted that they were a part of a brand-new business model.
M1 Finance charges no fees, no commissions, and no management fees. Furthermore, there are no account minimums. Smaller platforms like SoFi Invest have also replicated this business model, and even traditional brokers have been forced to reduce their fees in response.
So, how do these next-generation stock trading platforms make money?
It’s all in the other services offered. No longer is a broker just a place to hold your portfolio. To use M1 Finance as an example, they also provide loans, and a checking/savings account via their M1 Borrow and M1 Spend programs.
Create an account with M1 Finance, and you’ll also see that they offer a program called M1 Plus. It’s completely optional and comes with some additional perks for those who want to take advantage of them.
It shows that stockbrokers are thinking of new ways to charge their clients. The difference is their paid services are entirely optional. You’re not forced into paying fees simply for using the base functionality of the platform.
How New Stock Trading Platforms Have Changed the Game
Why should you care about any of this, and what does it mean for your stock trading portfolio?
In terms of the broader market, retail investors still make up a tiny percentage of the capital within the markets. Institutional investors and funds continue to command the most purchasing power.
On the other hand, platforms like Robinhood have been the site of people power in the past. The GameStop squeeze and the resulting silver squeeze disrupted markets.
Even today, the GameStop share price is still up by more than 100% since the squeeze started.
It shows that the influx of low-income investors can alter the markets in the face of the big dogs on Wall Street.
Brokers have been forced to transform their business models to meet the new demands coming from retail investors.
If you’re someone who only has a few dollars to invest in stocks, now you can. Many platforms, including SoFi Invest, even make fractional shares available to trade in, which enables you to put every dollar to work at all times.
Novices often look at traditional brokers and don’t pay too much attention to the prices. What’re a few dollars to add thousands of dollars of stock to your portfolio, after all?
And that’s the crux of the classic brokerage business model. Most people don’t care about a few dollars, but it’s the essence of nickel-and-diming people. Over time, these fees add up to substantial amounts.
Most investors lose a few percentage points of their portfolios every year when all the fees have been taken into account.
It’s why it’s so important that investors at all levels examine the fee structures of their brokerages and consider whether they need to make a move elsewhere. There’s no reason to accept second best with the massive wave of new alternative stock trading platforms.
To conclude, the old way of trading stocks, bonds, and other paper assets has ended. The smaller brokers are just as reputable as the heavy-hitters. Don’t allow yourself to be taken advantage of any longer.
Consider creating an account with an M1 Finance or a SoFi Invest to take advantage of an innovative portfolio-building experience with no fees. The power has shifted to the ordinary retail investor, so start investing in your financial future now.
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