Just a month after Charles Schwab announced that it was cutting online stock trading commissions to zero, it announced this week – its intent to acquire rival TD Ameritrade for $26 billion. If the deal to merge the country’s two largest discount brokerages goes through, the resulting company will become a dominant player with more than $5 trillion in assets, combining Schwab’s $3.8 trillion with TD Ameritrade’s $1.3 trillion.

But why would any company want to expand in a field that offers its product for free? The answer lies in the need for assets to drive order flow. While an investor may pay zero on a stock or ETF trade, the broker bundles the trades with others — then sells the order flow and collects rebates. On the institutional side, rebates have been captured for years and credited to the corresponding fund via the exchanges directly. The interest rate spreads on cash and margin balances are another area that offers the combined company opportunities as its assets grow. A quick glance at Schwab’s 2018 revenues shows that only 7% of the firm’s revenue came from trading last year — and 88% came from interest rate spreads and asset management and service fees combined. But, sacrificing the 7% hurt immediately with the implementation of the zero trading policy and now Schwab needs to make it up through TD Ameritrade’s assets.

Future Wealth’s View

In our article on Oct 20th, 2019 link is here https://futurewealthllc.com/desperate-times-call-for-desperate-measures/), we had posited that Schwab’s $0 commission is going to backfire. Since then, the company announced it was allowing investors to buy and trade fractional shares (another bad idea) and now it has been forced to merge with TD Ameritrade to keep the lights on. With trading revenues gone, it has made other revenue streams more critical to boosting margins and profits. Schwab is now hankering for clients and assets, that included a recent deal to acquire one million accounts and $90 billion in assets from USAA.

That said, Charles Schwab is no idiot. We suspect there is a grand plan behind all of these changes. The most obvious to us, at Future Wealth, is to allow direct indexing instead of requiring investors to buy mutual funds or ETFs tied to an index. Direct indexing will allow an investor to create their own index of stocks and with $0 commissions and the ability to own fractional shares, an individual investor can have their own basket of stocks for as little as $100 minimum investment with no additional cost or expense ratios that mutual funds and ETFs charge. In enabling that, Schwab gets the benefit of much needed order flow and each investor gets their own index.

ETFs shook up the mutual fund industry and direct indexing will kill it. Stay tuned – you will not want to miss this!