Charles Schwab is cutting its U.S. equity, ETF, and options base commissions to zero, effective October 7, 2019. Commission-free trades also apply to OTCBB/penny stocks. With $3.7 trillion in assets under management and 12 million customers, Schwab's move to eliminate those commissions is reverberating around the brokerage industry and putting pressure on the shares of Schwab (SCHW) and its competitors, TD Ameritrade (AMTD) and E*TRADE (ETFC).

Schwab's CFO, Peter Crawford, explains the firm's reasoning behind the price cuts, saying in a blog post, "It has seemed inevitable that commissions would head towards zero, so why wait? We have a business model that doesn’t depend on commission revenue, a long-term orientation and a history of being willing to disrupt ourselves based on client needs and competitive dynamics."

Crawford notes new entrants to the online trading market using zero or low equity commissions, and says, "We’re not feeling competitive pressure from these firms…yet. But we don’t want to fall into the trap that a myriad of other firms in a variety of industries have fallen into and wait too long to respond to new entrants."

Schwab's zero commission rates do not mean there are no trading fees. Options traders will no longer pay a base rate per leg, but commissions of $0.65 per contract will still be levied.

Financial Impact to Schwab

According to Crawford, Schwab estimates that this pricing reduction is equivalent to approximately $90-100 million in quarterly revenue, which roughly translates to 3-4% of total net revenue. He notes that commissions per revenue trade have been falling for multiple years, so the potential revenue impact in the coming quarters could very well be smaller, holding all else equal.

Investors may not be getting that math as shares of Schwab (SCHW) fell as much as 10% on the news.

Having one of the big players in the online trading industry eliminate their base commissions is a big step towards zero-cost trading across the board. 

What's it Mean For Individual Investors?

Keep an eye on your broker's fees, and look beyond commissions for equities and ETFs. How much interest is being paid for your idle cash? What other services does your broker offer? How much price improvement are your trades generating? What are the fees for the asset classes you trade most often? Zero commissions on equities doesn't affect the futures trader, for instance.

Interactive Brokers is quite upfront about their free trading program, saying that orders are routed to market makers to generate income for the firm. Robinhood also routes for payment for order flow, but they are not as open about it. You might not be paying a commission, but if you trade more than 200 shares at a time, it's likely that your "free trade" is costing you more than it's saving.

Once brokers commit to excellent trade executions in spite of low (or no) fees, then investors and traders will see real value.

Industry Response

Just last week, Interactive Brokers announced IBKR Lite, a new offering that will provide commission-free trades on US exchange-listed stocks and exchange traded funds (ETFs). This announcement comes on the heels of the launch of the dough app, which allows commission-free trading for a subscription fee of $1 per month. There are plenty of sites that offer commission-free trading, including Robinhood and TradeZero. Schwab's jump into the fray, however, becomes the elephant in the room that can no longer be ignored.

Zero commissions help traders and investors, but the industry as a whole has to find better ways to attract customers and generate activity. Schwab has made it clear that they are willing to sacrifice revenue to keep their clients on board.

Who's Next?

Eliminating commission revenue will hurt TD Ameritrade and E*Trade a lot more than it hurts Schwab. The market seems to agree. TD Ameritrade declined over 25% today and E*Trade dropped over 16%. Fidelity is privately held, so it's not clear how much revenue it generates from commissions.

Fidelity, however, seems to be staying out of this fray. A spokesperson points to the low rate of interest Schwab pays for cash balances as one way the firm generates revenue from customer assets, and further notes that Fidelity's cash sweep rate is ten times higher than that offered by Schwab. "The value offered at Fidelity is unmatched and we will always look for ways to leverage our scale to deliver even more value," says the spokesperson.

The Future is Here

What does this mean for investors and for the brokerage industry? Victor Jones, CEO of dough, said in a release recently, "In five years, paying for commissions to trade stock will be about as common as paying for a landline.” It seems the pages of the calendar have rapidly flipped, and we're already in 2024. Today, Jones tells Investopedia, "The reduction in pricing was an eventuality in the industry. These firms held on to dated and inefficient models as long as possible. Customers no longer see a valid reason to pay a commission to trade."