Earlier this year, the largest discount brokerage firms including Charles Schwab and Fidelity dropped their brokerage commission rates to $4.95 per trade. These rates apply to all accounts where the account holder opts to receive electronic access only to his or her account. All the brokerage firms are moving away from delivering paper statements and are using the stick of higher fees to influence consumer choice.
Until 1975, brokerage commissions were fixed by the New York Stock Exchange (NYSE) and overseen by the Securities and Exchange Commission. For example, in 1968 the NYSE set commission rates at $0.39 per share and discounts were not allowed for large orders. Therefore, buying or selling 1,000 shares of stock in late 1960s would cost $390 which is over 75 times as expensive as today’s discounted rate.
Stocks were also only quoted to the 1/8 of a dollar ($0.125) such that brokers earned significant trading revenue on the spreads between bid and ask prices. Sixteen years ago, the exchanges transitioned to quoting stock prices to the penny ($0.01). Therefore, trading spreads also narrowed by a factor of 12.
Broker dealers now earn the majority of their revenues through fees (especially on money market products) and interest income. For example, less than 10% of Charles Schwab’s revenue is tied to brokerage commissions. Therefore, we expect commission rates to continue to decline to the point where most trades will likely be executed without a brokerage commission.
Lower commission rates reduce the frictional costs associated with trading and investing. We are now able to create a diversified account of individual common stocks at much lower asset levels than before. In the past, we have used Exchange Traded Funds (ETFs) which hold hundreds of stocks each to diversify portfolios worth less than $100,000 since trading costs were much higher. For instance, at $20 per trade, it would cost $600 to buy 30 stocks in a portfolio. The same trading volume now costs only $148.50.
Lower trading costs could also theoretically increase the attractiveness of a high turnover strategy that involves more rapid buying and selling. We do not plan on increasing our turnover since we do not believe that market timing is a viable strategy and there are negative tax consequences to rapid trading.
The financial services industry has changed dramatically over the years and will continue to do so as technology advances and business models evolve. Similarly, our strategies will change to take advantage of new opportunities, but we will not alter our principles of sound fiduciary investment based on fundamental research of the securities in which we invest.