These Companies Are Charging Less and Making More

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The commission-price war between brokerages has been waging for a while now, and it might lead some to wonder how much it's hurting brokerages. The answer is that despite charging customers less, many brokerages are still doing well.

Let's review a few examples, such as E*TRADE Financial (NAS: ETFC) , which lowered its trading commission for most customers from $12.99 to $9.99 back in 2010. The same year, Charles Schwab (NYS: SCHW) lowered its rates from $12.95 to $8.95. TD AMERITRADE (NAS: AMTD) was already charging its online customers $9.99.

Growth and evolution
For the year ending in December 2011, TD AMERITRADE reported that its transaction-based revenue dropped 7% over year-earlier levels, but it still made up a whopping 42% of total revenue. Meanwhile, asset-based revenue rose 7%, giving the company a basically flat year overall. Trades per day clocked in around 367,000 for December, and were roughly flat over the year.

Those numbers can be partly explained by the stock market we experienced in 2011, with many investors not too eager to trade frequently, given the market's wild swings and its overall flat performance. They also reflect the fact that successful companies evolve over time. Just as banking reforms have caused many banks to find new fees to charge, brokerages collecting less in trading commissions are finding new sources of revenue. TD AMERITRADE and others, for example, have been hiring more financial advisors and making money by helping customers manage their assets.

Schwab has also been hiring advisors and beefing up its advisory business. In its third quarter, it reported core net new assets up 21% over year-earlier levels, and 2.4 million accounts in its retail advisory program, up 7% over the year before. One of E*TRADE's strategic goals is "expanding annuitized revenue," in part via a greater focus on managed investment portfolios.

The big picture for brokerages
It's important to always consider a company's big picture. Sure, commissions may be going down, but that's far from a death knell. If a brokerage is taking in less per trade than it used to, but its customer base is growing, it can still end up with net gains. In Schwab's third quarter, it reported 14% growth in new brokerage accounts over year-ago levels, and a 10-year average annual growth rate for total client assets of 9%. Those assets totaled $1.6 trillion, too. Meanwhile, E*TRADE has seen its growth rate for net new brokerage accounts and assets sputter or slow in recent quarters, but both are still growing.

Growing other parts of the business, such as asset management, can also bode well for a company's future, but investors in brokerages may want to keep an eye on this, lest companies get carried away. In 2005, BusinessWeek reported that regulatory bodies such as the NASD were concerned about fee-based accounts and whether they were serving customers well. Brokerages such as Merrill Lynch and UBS (NYS: UBS) had been promoting these accounts for customers, typically offering free trading while charging between 1% and 1.5% of assets annually.

That doesn't make sense for many investors, as 1% of a $500,000 account amounts to $5,000 in annual fees, which can be far more than trading commissions would have cost. Indeed, the NASD brought an action against Raymond James (NYS: RJF) , contending that it switched thousands of customers who hadn't traded in the previous year into fee-based accounts.

The big picture for investors
The information above has implications for anyone who uses brokerages to trade stocks and manage their money. When selecting the best brokerage for yourself, you don't necessarily need the one with the lowest trading commissions -- especially if you don't trade too frequently. If you're offered free trading, all the better -- but be sure it's not in exchange for an arrangement ill-suited for your needs.

When trading, what really matters is that you don't spend too much of any given trade on the commission, especially if you trade relatively frequently. Aim to keep it at 2% or less. With a $10 trading commission, that requires a minimum $500 trade. If your commission is $25, aim to buy or sell at least $1,250 worth at a time.

With commission costs that are low or very low, both brokerages and consumers can prosper.

At the time this article was published

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