How Does ETRADE Make Money?

Boring topic huh? Except Etrade’s business model isn’t to get you to trade. Its to get you to deposit.

There are a number of ways of making money from money. One is fee for service. Its a bit like a cake delivery service. Two people are trading some cake, you deliver the cake and take a few crumbs for yourself. Do that fifty times and you’ve had more than the whole cake. That is much of investment banking.

Another one is the AirBnB of money. Not doing anything with your accumulated life savings of $1,000? Tell you what, I’ll pay you $5 for it and lend it to the other guy for $35. That is retail banking.

Sometimes though, you get a company that pretends to be a cake delivery service, but is actually a secret AirBnB of your savings. That business is ETrade.

How does etrade make money

Image: Karlis Dambrans

E*TRADE

Right now, ETrade charge $9.99 for each stock trade. You buy and sell a lot and you pay less. However, because of stuff like options or using a phone, on average they get $10.66. In the first three months of 2016, these commissions added up to $107m.

Taking your deposits you temporarily put in their hands and lending that out – that was worth almost $300m in revenue.

ETrade makes three times the money lending out your cash balance than they do providing the trading service you originally went to them for. They’re not cheating you in any way, I mean they could easily charge you $19.99 for each trade. But then they wouldn’t make as much money.

Feels crazy right, them taking your money, paying you nothing, and lending it out to a day trader on margin at 8%. But this is business, they are giving you value and making money on it any way they can.

About ten years ago, I was doing my stock trading on the American Express Share Trading service. And they used to pay a crazy interest rate on my deposits, around 4-5%. This made sense for Amex because of course they need to fund the credit card debt they issue. However, it likely made their stock trading business rather unprofitable, and may explain why that platform is no longer around.

When your competitors are making money, not copying can hurt.

E*TRADE’s business model

  1. Offer people a great place to buy stocks.
  2. Individuals deposit some cash and start trading.
  3. E*Trade makes $10 on your trades and a $2 per year spread on each $100 you deposit

ETrade are trying to expand into asset management and pensions, all in order to provide you with more value and more reasons to deposit cash with them.

Simple right?

Yea it is, except there’s a little feature of the online brokers you may not have heard about.

Institutional brokers like Citigroup pay ETrade to send YOUR trades to Citigroup.

SEC Rule 606

The SEC has had a good look at “payment for order flow”, as this sort of thing is called. Mostly they found that individuals get a good deal, with quick settlement and price improvement.

etrade makes money routing your trades

Image: ETrade’s SEC 606 disclosure

This table identifies where ETrade are sending your orders. All these firms pay ETrade between $1 and $3 when ETrade routes them a customer’s buy OR sell order for 1,000 shares.

What’s going on is that small investors trade in a predictable way. They put a bunch of orders on overnight that all get executed in the morning, then it is a steady flow with a bounce around lunch and more into the close.

Generally, small investors are evenly matched between buy and sell orders.

Institutions like hedge funds, whenever they come in, will move the market. They’re like Jabba the Hutt, always looking for someone to push around. They love buying from small investors. They know they get a great price from them.

Typically institutions pay 1c a share to trade, or $10 per 1,000 shares.

The firms paying Etrade are taking the difference between $3 and $10.

How does Robinhood make money

Image: ikeepemclean

Robinhood App

This brings us to the newest player in the online brokerage market, Robinhood. They offer commission free trading.

They claim that they are making money on interest, but because they haven’t started doing any margin lending yet, nearer term it is funding itself by routing your trades to firms that pay for you.

In the first three months of 2016, most of Robinhood’s partners paid them $2-3 for each 1,000 shares sent their way.

How Does Robinhood Make Money?

  1. Develop a free platform for you to trade shares.
  2. Make money selling your flow to institutional brokers.
  3. In the future lend out your cash as margin loans.

Personally I cannot wait for Robinhood to come to the UK, even though it is a bit like having a free maid service paid for by the company insuring your diamond ring!

Quick joke: How does a day trader end up worth $1m dollars?

He starts the day with $5 million.

But you’re better than that guy – because you’re a long term investor 🙂

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Yuen Lo

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