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Shares of discount brokerages TD Ameritrade (AMTD - Get Report), E*Trade Financial (ETFC - Get Report) and Charles Schwab (SCHW - Get Report) rebounded this week after getting hit on Tuesday by news that Wells Fargo (WFC - Get Report) will offer free trades.
The online brokers were boosted in part by news Wednesday from E*Trade that trading volumes and client assets grew at a healthy clip in January.
Here's the other part: These online brokerages get a disturbingly high portion of their revenue and income because they enjoy virtually free loans from their customers. If customers wise up and take away the cheap money -- which they can easily do -- the brokerages will suffer.
Cheap MoneyPicking up on a practice started by Merrill Lynch (MER) in 2000, the online brokerages offer laughably low default interest rates on idle cash in client brokerage accounts. Ameritrade and E*Trade pay a paltry 0.1% for balances up to $5,000 and 0.4% for cash balances of more than $25,000. Because customers could earn as much as 4.8% in a money market account -- the kind of vehicle idle cash used to go into before Merrill Lynch changed things -- clients are giving up considerable sums. On a balance of $10,000 for a year, they forfeit about $440. Charles Schwab is a little better. It pays 1% as a default rate on idle cash for balances up to $100,000. Yet all three brokerages offer much better rates to clients who ask:
- E*Trade customers can sweep brokerage account cash into a bank savings account that pays more than 5%. There are no minimums and no restrictions on how long the cash has to stay in the savings account, so the change wouldn't hurt active traders.
- Charles Schwab clients can sweep excess cash into money market funds that pay an annual yield of 4.7%. The initial minimum is $2,500, but after that it's $500. Clients can move cash out after one day without penalty.
- Ameritrade customers with $100,000 in assets can earn about 4.4% in a money market fund with an initial purchase of $5,000 and a minimum of $2,000.