Cheap Money May Cost Discount Brokers
This column was originally published on RealMoney
on Feb. 16 at 10 a.m. EST. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney,
Shares of discount brokerages TD Ameritrade (AMTD), E*Trade Financial (ETFC) and Charles Schwab (SCHW) rebounded this week after getting hit on Tuesday by news that Wells Fargo (WFC) 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.
But the troubles for the online brokers are far from over, in my view, and free trades from competitors such as Wells Fargo and Bank of America (BAC) are only part of the problem.
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.
Select the service that is right for you!COMPARE ALL SERVICES
Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
- Weekly roundups
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Upgrade/downgrade alerts
Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.
- Diversified model portfolio of dividend stocks
- Alerts when market news affect the portfolio
- Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.
- Real Money + Doug Kass Plus 15 more Wall Street Pros
- Intraday commentary & news
- Ultra-actionable trading ideas
Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.
- 100+ monthly options trading ideas
- Actionable options commentary & news
- Real-time trading community
- Options TV