A new NerdWallet study examined the trading patterns of online investors and found that they are overpaying by more than $1.8 billion per year.
NerdWallet Study Key Findings:
- At least 17 million investors overpaying for online brokerage
- Only 12% of commission fee is used for trade execution at top brokerages
- Over $1.8 billion per year wasted on unused premium services
When you pay commission fees for online stock trades, where does that money go? Do you get better execution by paying $9.99 to TD Ameritrade than by paying $1 to Interactive Brokers? How much better? Enough to justify the difference in price?
The three largest online brokerages (Schwab, TD Ameritrade, and E-trade) have over 17 million active brokerage accounts, each typically charging $7.99 to $9.99 per trade. Yet there are dozens of less expensive brokerages that provide trade execution of comparable quality, many providing low cost alternatives for research and trading platforms as well. The same services offered by the big three can be obtained for a tiny fraction of the price, saving the average user $110 per year, or a total of over $1.8 billion in aggregate.
Where do trade commissions go?
NerdWallet’s study analyzed the official financial statements of the three largest online brokerages and found that the extra cost of going with a “name brand” brokerage went to pay for advertising and overhead expenses, not higher quality services. The big three brokerages spent only 12% of their expenses on trade execution, with the rest going to advertising (11%), employees (40%), physical infrastructure (13%), and legal and other indirect operating expenses (24%). By contrast, deep discount brokers Interactive Brokers and Speed Trader spent an average of 59% on trade execution, 7% on advertising and general expenses, 27% on employee costs and 7% on physical costs. Legal and other indirect expenses were negligible.
What do you get for the added price?
NerdWallet spoke with consumers who used the big three brokerages and found that although they knew they could pay less for trades at a deep discount broker, they felt they were getting something extra by paying more. The most cited advantages were excellent trade execution, access to research and trading tools, and the peace of mind that comes with investing in a trustworthy brand. But do these advantages really justify the added cost? NerdWallet decided to investigate the numbers behind these claims.
E-trade executes trades in an average of 0.26 seconds and Schwab in 0.10 seconds. Interactive brokers executes at an average speed of 0.90 seconds. So if you are paying $9.99 for E-trade rather than $1 for Interactive Brokers, you are paying 10x the commission to shave 0.64 seconds off your trade execution. This may make sense for the rare high frequency statistical arbitrage trader, but the majority of the 17 million customers of the big three brokerages will never be impacted by the difference. While these companies’ filings do not disclose what proportion of their customers are high frequency traders for whom fractions of a second matter, they do disclose that the average customer executes less than two trades per month. It is therefore highly likely that a fraction of a second difference in execution time is not meaningful to the vast majority of customers.
Access to Research & Trading Software
The big three brokerages all offer their customers a streamlined experience with access to research reports and analytical software. Could this justify paying the extra cost? Again, the numbers unequivocally say no. There are over a dozen brokerage accounts that offer research reports, real-time data, and analysis software for less than the cost of the big three. For example, Scottrade includes these services for free and charges only $7 per trade, less than all of the big three. Barron’s gives Scottrade fantastic reviews for its charting and execution capabilities. Merrill Lynch’s Edge account similarly provides these services for only $6.95 per trade. Deep discount broker Lightspeed and others will give you comparable access for $1 per trade. The quality? “Terrific,” according to Barron’s.
Reputation & Trust
When the researchers confronted ordinary investors with the fact that they were overpaying for basic services, the investors almost universally cited their brokerage’s reputation as their justification. They simply did not feel comfortable trusting their investments with a company they had never heard of and were willing to pay more for a big three brokerage. It’s hard to put a dollar value on the feeling of security that name brand brokers provide, so it could be argued that peace of mind is worth the cost. Nevertheless, this justification is largely irrational. Interactive Brokers, which charges $1 or less per trade, has been around since 1977 (five years before E-trade), has nearly 200,000 customer accounts, and was paid more in trade commissions last year than E-trade. The idea that this company is more likely to abscond with one’s investment portfolio is not justified by the facts.
Further protecting investors are the slew of government and pseudo-governmental agencies that are tasked with overseeing the brokerage industry. FINRA (Financial Industry Regulatory Authority) is a non-governmental organization that self-regulates brokerage firms. The SIPC (Securities Investor Protection Corporation) protects investors from brokerage insolvency. Investors who trade with organizations that are members of these widely respected institutions can count on their brokerage having been carefully vetted.
The Perfect Brokerage Account
The facts indicate that, for the vast majority of investors, the cost of a popular “name brand” brokerage accounts cannot be justified by the services provided, but does this mean a deep discount broker is right for everyone? Not necessarily. Some investors trade non-equity products, which are only available at a limited subset of online brokers. Others require mobile app access so they can trade on their smartphone. While some investors trade on margin and want the lowest borrow rate, others want to trade ETFs commission-free. The list goes on and on and it soon becomes clear that there is no single perfect brokerage account for everyone.
NerdWallet has addressed this issue by creating a brokerage fee comparison tool that analyzes the costs and features of more than 70 different online brokerage accounts available to investors in the U.S. Investors can input their trading habits and desired account features and the tool will return a price-ranked list of every online broker that provides the requested services. NerdWallet’s tool is the first to take into account promotions and other complexities, which affect the investor’s total cost-per-month. These tailored results are free and completely unbiased.
Preferences the tool can incorporate:
- Trade volume
- Trade frequency
- Account Minimums
- Asset classes (stocks, bonds, options, futures, currency, and more)
- Research tools (Research reports, Real-time data, Analysis software)
- Broker Assistance
- 24/7 Support
- Physical locations
- Mobile access
- Wire Transfers
- Paper Statements
- Debit cards
- …and many more
Additional Brokerage Resources:
- Tool: Find the Cheapest Broker for Your Unique Trading Needs
- Analysis: Best Brokers for Analytical Traders
- Analysis: Best Brokers for High Quality Service and Research
- Analysis: Least Expensive Online Brokers for Basic Trade Execution
About NerdWallet Financial Markets
NerdWallet’s Financial Markets team is committed to empowering investors by providing transparent access to information on financial markets and the economy. From tools that simplify complex issues to in-depth studies with innovative analysis, NerdWallet Financial Markets serves those seeking unbiased information.
- See also: Interested in learning how to invest, or ready to get started? Check out NerdWallet’s picks for the our favorite online brokerage accounts for new and experienced investors alike.