How Will Zero-Fee Investment Platforms Impact Traditional Stock Brokers?

The retail investment space is changing at an exponential pace. In times gone by, the only way to access the financial markets would be to use a conventional stock broker.

This would typically require a one-on-one telephone call, which would result in the stock broker manually purchasing or selling your required order.

Fast forward to 2019, and trades can now be placed online at the click of a button. In fact, the process of opening an account, passing a basic KYC check, and subsequently purchasing shares has never been easier.

With that being said, the online stocks and shares arena is now ready for its next transition - fee-free trading.

With the likes of Robinhood and eToro now offering retail clients the opportunity to buy and sell thousands of equities without incurring any conventional brokerage fees, does this effectively make the traditional stock broker redundant?

The Status Quo are being challenged

When we talk about the ‘status quo’ in the discussion of the online brokerage industry, we are typically refer to the likes of Charles Schwab, Fidelity or TD Ameritrade.

These are hallmark institutions that have been offering their services for decades on-end, have amassed a global reputation for reliability, security, and credibility, and usually - have billions, if not trillions of dollars’ worth of assets under management.

In return for this hallmark reputation, the aforementioned brokers will charge their rightful fee. This usually comes in the form of a fixed trading fee that is charged on each buy and sell order, and in some cases - a monthly or annual account maintenance fee.

Moreover, established stock brokers will often demand minimum account balances, and a rather stringent KYC verification process.

Taking all of the above into account, a new breed of stock broker has risen to almost instant-fame. For example, innovative Fin-Tech platforms such as eToro allow new customers to open an account in a matter of minutes.

This isn’t at the expense of domestic and regional anti-money laundering regulations. On the contrary, eToro utilize cutting-edge identity verification systems to on-board new customers in a matter of minutes.

Users are simply required to upload a copy of their government-issued ID (such as a passport or driver’s license), and the underlying system takes care of the rest. This is a far cry from the status quo - who often requires days - if not weeks to onboard new clients.

However, as beneficial as a seamless account opening process is, customers are most attracted to the significant trading fee discounts that are now available.

Are trading fees a thing of the past?

If you're actively involved in online stocks and shares space, then it's likely that you've heard of Robinhood. Launched as recently as 2013 – the US-based broker is known for its zero-commission stocking trading structure. Not only does this cover thousands of traditional blue-chip equities, but other asset classes too.

Whether it's exchange traded funds (ETFs), options, or Cryptocurrencies like Bitcoin and Ethereum, retail traders will pay nothing in fees. In this sense, it’s a no brainer for everyday traders.

Due to the sheer popularity of the Robinhood fee-free trading framework, the company has since expanded into foreign shores. For example, it was recently announced that the online broker received the green light from UK regulators the Financial Conduct Authority to offers its services in Britain.

Although the UK is Robinhood's first international market, it's likely that more countries will soon follow suit. As per Robinhood president Wander Rutgers - "Today marks the beginning of a new chapter for Robinhood, and we're excited to take the first important step towards bringing our investing platform to customers in the UK."

Is ‘free’ really free?

It is important to differentiate between ‘zero-fee’ trading and ‘zero-commission’ trading. While the two terms are often used interchangeably, there is a fundamental difference.

Regarding the latter, zero-commission trading is a common marketing ploy utilized by a plethora of brokers active in the online space. In layman terms, this means that you will not pay any fees to place a trade.

However, you might be required to pay a monthly or annual maintenance fee to take advantage of this favorable pricing arrangement.

More commonly, zero-commission brokers might not charge anything to buy and sell equities, albeit, the spread will be considerably high.

This more than counters any potential savings you might have made by not paying any commission.

In the case of Robinhood, the general consensus is that these hidden fees are often embedded in stock prices. As per the Wall Street Journal, this is initiated by executing an order at a price much worse that would be available via a traditional broker.

For example, the likes of Charles Schwab, Fidelity and TD Ameritrade will often obtain blue-chip shares on behalf of their clients at a stock exchange price difference that rarely exceeds a penny.

On the contrary, it remains to be seen what share prices customers of Robinhood are accustomed too.

Nevertheless, retail clients - especially those with little understanding of the financial markets, are drawn to platforms like Robinhood purely for the fee-free offering, irrespective of the underlying buy/sell price.

How do fee-free platforms actually make money?

One of the most commonly asked questions regarding fee-free investment platforms is how the online broker in question actually makes money.

First and foremost, the likes of Robinhood claims to make the majority of its revenues via its margin trading services. This is where traders are able to purchase equities at a greater value to what they have in their account.

Moreover, the broker will also charge a fee to import securities from an external stock broker. However, one of the most under-discussed revenue streams for Robinhood is the 'Payment for Order Flow' arrangement it has with high-frequency traders.

In a nutshell, when a customer of Robinhood places a trade, the platform will then forward the order to a high-frequency trader. In return, Robinhood will receive cash from the company it sold the trade to.

Such an arrangement will typically result in the seller receiving a rebate from the high-frequency trader. However, it remains to be seen if customers of Robinhood benefit from this cash-for-order system.

Irrespective of how Robinhood makes its money, financial backers can’t seem to get enough of the company. In fact, as per the broker’s latest funding round, Robinhood’s most recent valuation stands at a staggering $7.6 billion.

Are traditional stock brokers bothered?

Although fee-free trading isn’t technically free - at least when you consider the difference between the equity prices traded on the stock markets and those available at broker’s like Robinhood, the lure of fee-free trading is enough to attract a significant following.

In fact, with Robinhood and industry-counterpart eToro now responsible for over 5 million and 3 million customers respectively, traditional stock brokers have of course taken notice.

Interestingly, this is no different to the ever-growing challenger banking app space. With players such as Revolut, N26 and Monzo now taking the European banking scene by storm, a number of established financial institutions have begun to launch similar products.

In the case of the traditional stock broker, it’s all-but certain that change is on its way. For customers to take notice, traditional brokers like Charles Schwab, Fidelity and TD Ameritrade need to focus on two key metrics.

Firstly, and perhaps most importantly, established players must reassess their pricing structures. When push comes to shove, everyday retail traders are primarily concerned with fees.

If they are able to buy and sell equities at a cost significantly lower than the status quo, then they will have no issues making the transition.

At present, traders are typically charged a per-order fee at both ends of the trade. While this doesn’t have much of an effect on those that buy-to-hold, this makes it highly uncompetitive for investors involved in short-term trading.

Secondly, and much like in the case of the challenger banking arena, traditional stock brokers need to make the digital transformation by making full use of emerging technologies like artificial intelligence, robotic process automation, and machine learning.

As is the case with modern-day brokers like eToro and Robinhood, the aforementioned technologies allow platforms to on-board customers with ease.

By facilitating a positive end-to-end customer experience, traders are more likely to remain on the platform long-term.

At present, traditional stock brokers still utilize paper-based systems that results in long onboarding delays. From the perspective of the new customer, this can be a highly frustrating experience.

The Bottom Line?

In summary, traditional stock brokers need to stand up and take notice of investment platforms like Robinhood. Everyday traders are flocking to the platform at an incredible rate, not least because they are lured by the prospect of fee-free trading.

Although trading it not technically free in its entirety, the underlying costs are still significantly lower in comparison to the status quo.

However, it is also important to recognize that investors are not onlyinterested in the fee-free trading structure that the likes of Robinhood offer.

With an account opening process that often takes minutes, an ability to trade at the click of a button via a mobile application, and an all-round more convenient user-interface – modern-day investment platforms are fully catered for the digitally-savvy Millennial demographic.

Disclaimer: The content of this article is sponsored and does not represent the opinions of Finance Magnates.