Discount Brokerage

Easy sell: it’s good to know how your counterparties are making money.

Most of my clients are customers of discount brokerages of some sort. I’m one as well.

In the case of a brokerage service like TD Ameritrade, Interactive Brokers, Robinhood, or Charles Schwab, the answer to this question can be kind of difficult. Thankfully Patrick McKenzie from Stripe wrote an exceptional blog post addressing the question, “how do discount brokerages make money?”

Highly recommend the full read if you’re interested, but I’ll summarize: mostly, from making a spread on cash balances held in customer accounts.

Best to just quote Patrick here.

Suppose I were to give you $100, in return for your promise to give it back when I wanted it and pay me 0.27% annualized interest in the meanwhile. Suppose you invested this in a virtually riskless bond, perhaps a mortgage-backed security with government backing, offering 2.53% annualized interest. You’d earn $2.26 in net interest in a year.

Suppose I were to give you $200 billion dollars. Now I’m the American middle class and you’re Charles Schwab. You would earn something like $5.8 billion dollars in net interest income. This would entirely pay for your sideline business in running a brokerage. Stocks, bonds, mutual funds, branch offices, call centers, blah blah blah, it all exists to justify the only pricing page that matters, and all the verbiage on the pricing page is about how much you pay the customer.

I deal with brokerages every day of the week and yet, I was still surprised by this. Cash balances at brokerages are the name of the game. Commissions, in Patrick’s opinion, will converge to zero, but the spread here on net interest is the juice they are squeezing.

Some food for thought next time you read your brokerage statement.