Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.
Support MFO
Donate through PayPal
Schwab Muscles Its way To The Top Of A Zero-Fee World
FYI: For decades, Charles Schwab Corp. quietly plotted to unleash its ultimate weapon against rivals: $0 fees.
Schwab considered eliminating charges in the 1990s after the advent of online trading, and again in the 2000s during the financial crisis, according to a person with knowledge of the matter. Each time, it dismissed the idea as too risky — a danger to its own bottom line.
As the Vegomatic article alludes to I would expect other costs/fees to rise to cover the loss of commission fees along with the implementation of new fees for other services. I would also expect that most current customers would just pay them because of the hassles of moving elsewhere.
I particularly enjoy this statement from your linked article:
"Registered Investment Advisors (RIAs) aren’t discount brokers and yet have to be mentioned in a discussion of them. A RIA is, basically, an investment salesman who moonlights as an amateur psychologist with better math skills than most psychologists. They mostly charge a percentage of your net worth for amateur psychology, worksmanlike math, and non-expert-but-credentialed investing advice. The investment stores are happy to provide backend services to investment salesmen, because RIAs control a huge portion of the mass affluents’ investable assets."
I'm not picking on RIA's; as they likely save the arse's of many folks who don't know how twitchy they become when their investment choices don't travel the expected path.
I've known numerous folks who have RIA managed accounts and for the most part are probably better monetarily postitioned for not having meddled on their own behalf. My biggest grudge against the large organizations through which RIA's operate is the sweep account methods. At request, I've reviewed several portfolios from those who trust my input (devil's advocate). I found too often, what I considered mismatched investments based on the account holders age, their perceived risk tolerance and other assets; and oversized amounts of account money parked in the "cash" sweep account paying almost zero yield. 'Course we understand this is cash flow at some point for whatever institution the RIA is affiliated. The first sweep accounts I first became aware of were RIA's connected with the U.S. arm of RBC (Royal Bank of Canada, Wealth Management). I noted to those asking me a few questions, that when 20% of your money is parked in the sweep account waiting for an investment opportunity by your RIA, this portion of your account has a yield of .15% or whatever the number might be at the time; which is likely similar to the yield for a bank or credit union savings account. This isn't a problem, unless this 20% cash position seems to always be in the account waiting for opportunity. A million dollar account has a $200k portion not even beginning to keep up with inflation.
"Vanguard’s flagship funds charge about 10 bps for wrapping the entire stock market, SPY (an ETF, which structurally has lower costs) does it for 4 bps"
Since Vanguard funds have an ETF share class, they share the structural cost advantage of ETFs viz. being able to offload trading costs onto authorized participants. Meanwhile, SPY has a structural disadvantage relative to index funds (whether in ETF or OE format), in that it is organized as a UIT, forcing it to endure cash drag.
SPY invests in 500 stocks, a far cry from the entire stock market. Its ER is 9.5 bp, not 4 bp. VOO costs 3 bp for wrapping the same 500 stocks. (VFIAX is 4bp.) Similarly, VTI which does wrap the entire stock market (at least the US part) also costs 3bp, and VTSAX costs 4bp.
---
"“Sweeping” is a term of art by which money automatically leaves the brokerage accounts to rest peacefully on the balance sheet of a bank every night and then be back in the brokerage ready for the morning bell. ... All discount brokerages have a sweep available"
That's certainly a "sweeping" assertion. What about VBS (Vanguard)? It pays enough on its MMF that a bank sweep would be a losing proposition. Though as Vanguard notes, MMFs are not FDIC insured.
Speaking of which, if the money is back in the brokerage ready for the morning bell, how do brokerages advertise FDIC-insured sweep accounts? The blogger is conflating the practice of banks doing "overnight sweeps" to enhance their profits with brokerages offering sweep accounts.
One can infer he is thinking about the former from his passing reference to bank regs and capital sufficiency ratios - this is a part of why banks sweep money out of customers' bank accounts overnight. See the first full paragraph of this ICI paper on p. 44 (pdf p.54).
Rather, brokerages sweep money into bank accounts until it is needed for settlement, not just overnight. Here is Schwab's disclosure, describing how it keeps most of the money in a Schwab Bank MMA and a small amount in a DDA (demand deposit account, aka checking account).
And E*Trade's disclosure of its Extended Sweep Deposit Account program, which says that you're not FDIC-insured until the money actually hits the target bank. Also, that the money is withdrawn from the deposit banks in order to cover debit balances in the brokerage. Not to move the balance back to the brokerage daily.
---
Payment for order flow? The blog presents this an an unalloyed good; better than market execution plus a cash bonus. Better, but not best. One often winds up losing this way.
It creates an incentive for brokers to send orders to whoever pays the most, rather than the place that might get the best outcome for customers. ...
Canada has banned the practice. The United Kingdom recently put it under review and said in September that nearly all UK-based brokerages acting in an agency capacity had stopped accepting payment for order flow.
For their part, market makers say they give, on average, a better price than the market is offering, usually a fraction of a penny per share.
Comments
Excellent detailed discussion, including:
1. What is a discount brokerage?
2. Who are and are not discount brokerages?
3. So how do discount brokerages make money?
I particularly enjoy this statement from your linked article:
"Registered Investment Advisors (RIAs) aren’t discount brokers and yet have to be mentioned in a discussion of them. A RIA is, basically, an investment salesman who moonlights as an amateur psychologist with better math skills than most psychologists. They mostly charge a percentage of your net worth for amateur psychology, worksmanlike math, and non-expert-but-credentialed investing advice. The investment stores are happy to provide backend services to investment salesmen, because RIAs control a huge portion of the mass affluents’ investable assets."
I'm not picking on RIA's; as they likely save the arse's of many folks who don't know how twitchy they become when their investment choices don't travel the expected path.
I've known numerous folks who have RIA managed accounts and for the most part are probably better monetarily postitioned for not having meddled on their own behalf. My biggest grudge against the large organizations through which RIA's operate is the sweep account methods. At request, I've reviewed several portfolios from those who trust my input (devil's advocate). I found too often, what I considered mismatched investments based on the account holders age, their perceived risk tolerance and other assets; and oversized amounts of account money parked in the "cash" sweep account paying almost zero yield. 'Course we understand this is cash flow at some point for whatever institution the RIA is affiliated. The first sweep accounts I first became aware of were RIA's connected with the U.S. arm of RBC (Royal Bank of Canada, Wealth Management).
I noted to those asking me a few questions, that when 20% of your money is parked in the sweep account waiting for an investment opportunity by your RIA, this portion of your account has a yield of .15% or whatever the number might be at the time; which is likely similar to the yield for a bank or credit union savings account.
This isn't a problem, unless this 20% cash position seems to always be in the account waiting for opportunity. A million dollar account has a $200k portion not even beginning to keep up with inflation.
Have a good remainder.
Catch
Since Vanguard funds have an ETF share class, they share the structural cost advantage of ETFs viz. being able to offload trading costs onto authorized participants. Meanwhile, SPY has a structural disadvantage relative to index funds (whether in ETF or OE format), in that it is organized as a UIT, forcing it to endure cash drag.
SPY invests in 500 stocks, a far cry from the entire stock market. Its ER is 9.5 bp, not 4 bp. VOO costs 3 bp for wrapping the same 500 stocks. (VFIAX is 4bp.) Similarly, VTI which does wrap the entire stock market (at least the US part) also costs 3bp, and VTSAX costs 4bp.
---
"“Sweeping” is a term of art by which money automatically leaves the brokerage accounts to rest peacefully on the balance sheet of a bank every night and then be back in the brokerage ready for the morning bell. ... All discount brokerages have a sweep available"
That's certainly a "sweeping" assertion. What about VBS (Vanguard)? It pays enough on its MMF that a bank sweep would be a losing proposition. Though as Vanguard notes, MMFs are not FDIC insured.
Speaking of which, if the money is back in the brokerage ready for the morning bell, how do brokerages advertise FDIC-insured sweep accounts? The blogger is conflating the practice of banks doing "overnight sweeps" to enhance their profits with brokerages offering sweep accounts.
One can infer he is thinking about the former from his passing reference to bank regs and capital sufficiency ratios - this is a part of why banks sweep money out of customers' bank accounts overnight. See the first full paragraph of this ICI paper on p. 44 (pdf p.54).
Rather, brokerages sweep money into bank accounts until it is needed for settlement, not just overnight. Here is Schwab's disclosure, describing how it keeps most of the money in a Schwab Bank MMA and a small amount in a DDA (demand deposit account, aka checking account).
And E*Trade's disclosure of its Extended Sweep Deposit Account program, which says that you're not FDIC-insured until the money actually hits the target bank. Also, that the money is withdrawn from the deposit banks in order to cover debit balances in the brokerage. Not to move the balance back to the brokerage daily.
---
Payment for order flow? The blog presents this an an unalloyed good; better than market execution plus a cash bonus. Better, but not best. One often winds up losing this way. https://www.reuters.com/article/us-usa-brokers-fees/u-s-online-brokers-still-profiting-from-dumb-money-idUSKBN1WN1UD (Oct 8, 2019)