Online brokers make a whole lotta money

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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.

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