Online brokers make a whole lotta money

I had lunch Tuesday with Don Montanaro, CEO of a newish online brokerage called TradeKing. In case you hadn’t heard, the online brokerage business is back, with record volume in February.

Montanaro was one of the founders of Suretrade.com, an early online broker later devoured by Fleet which was itself later devoured by Bank of America. TradeKing launched just over a year ago and now has about 35,000 customers. Its selling points are low prices ($4.95 a stock trade and 65 cents an option contract), a lot of data and analysis tools for options traders, and some cool community stuff–like the page where you can watch recently executed trades. Customers can also set up blogs to discuss their ideas and trades, and Montanaro has one too.

So it’s an interesting little company. But the really interesting revelation for me came when Montanaro told me other online brokerages “have 55% to 60% pre-tax profit margins.” That is, 55% to 60% of the net revenue they bring in is pure profit. “We’re private and we’re not running 60% profit margins,” Montanaro hastened to add. Neither are Charles Schwab (31%) or E*Trade (45%), since both are now as much asset gatherers (like banks) as brokers. But TD Ameritrade had a 52% pretax margin last year (the other two members of what Montanaro calls “the oligarchy” that dominates the business, Fidelity and Scottrade, are privately held), and specialist broker optionsXpress 70%. (And people complain about newspapers and their 20% profit margins!)

Every cent of those profit margins is money being taken out of the pockets of customers who are trying to make their money grow. So their money would presumably grow significantly faster if their brokers weren’t so profitable. That’s the funny thing about the financial services business. Pay a lot for a watch, and you get a fancy watch. Pay a lot for a mutual fund or stock trades and you get … less money.

Spain’s Prime Minister Warns Country Is in Danger of Being Shut Out of Markets

MADRID — Spain‘s prime minister warned Wednesday that the country faced the danger of being locked out of international markets as investors continued to fret about the future of the euro and Greece’s place in the 17-country eurozone.

“Right now there is a serious risk that (investors) will not lend us money or they will do so at an astronomical rate,” Mariano Rajoy told Spanish lawmakers.

al

The “game” of it is that when they quote stuff like “$9.95 a trade” 99% of it is pure profit as electronic trading only costs at most a few pennies per execution if that.
http://time-blog.com/curious_capitalist/ Justin Fox

They do have to spend a bunch of money to set up (and keep up to date) an online trading platform that can service hundreds of thousands of customers–and deserve some return on that investment. But yeah, after that it’s pretty much all profit.
Andrew Frazier

A Random Walk down Wall Street (8th edition) sums it all up nicely
“Actually, the costs of trading were larger than most online brokers advertised since much of the cost is buried in the spread between advertised since much of the cost is buried in the spread between a dealers “bid” price, the price at which a customer can sell, and the “asked” price, the price at which a customer could buy.” – Burton G. Malkiel

In some cases the bid to ask price is spread by more than 20%! (this is more the case with small capitilization stocks)
I have Scottrade and I have become disgusted with the amount the bid to ask price is eating away at my profits.
Jesse

This may be the case. However it sure beats paying 50 bucks a trade or more for a traditional broker or once a year 2 % fee on my portfolio. I’ll take 10 bucks a trade even if they’re margins are huge!