There's No Free Trading Lunch -- More Online Brokers Turning to Fees

Under pressure to add more and more services but also boost the bottom line, newfangled online brokerages are turning to an age-old Wall Street practice -- fees.

TD Waterhouse (TWE) and E*Trade (EGRP) say they plan to institute a $15 quarterly fee on brokerage accounts with less than $5,000 in assets at the end of this year.

In TD Waterhouse's case, customers who make more than four trades over 12 months will be exempt from the "inactivity" fee. Previously, the New York based brokerage owned by Canada's Toronto Dominion Bank (TD) had a $1,000 minimum to open an account and no quarterly fee. Customers can combine multiple TD Waterhouse accounts to meet those minimums. At E*Trade, customers with combined assets among accounts of $20,000 or who make one trade in a six-month period can avoid the fee.

Industry leader Charles Schwab (SCH) already had a $15 quarterly minimum balance fee, but on April 1 it raised the balance to avoid the fee to $20,000 from $10,000. (It also has exemptions based on four trades in the previous 12 months or on combined account assets for instance.)

This shift that makes brokerage accounts look more like some bank accounts may make some customers unhappy (just check out the Yahoo! message board for E*Trade) but it helps brokers' bottom lines by building fee revenue and weeding out some costly smaller accounts. Smaller accounts cost brokerages more because they bring in less in commissions and interest on margin loans. And given Wall Street's emphasis on earnings, that's important if the brokers want their battered stocks to move up.

"It's very difficult to make money on small accounts," explains Greg Smith, an analyst at Chase H&Q. "The only way it can be profitable is if they trade a lot, but in a $5,000 account people aren't daytrading that much." (His firm has done underwriting for E*Trade but not for Schwab or TD Waterhouse.)

As trading volume falls with the stock market's decline, online brokerages are using a variety of methods to continue growing revenues. E*Trade, for instance, bought a bank earlier this year and TD Waterhouse raised its commission on equity limit orders just a few months ago. Online brokerages need more revenue to help pay for their expanded services, like banking, financial advice or products like IPOs.

TD Waterhouse spokeswoman Melissa Gitter said the move is designed to keep services up and commissions down. "This is really designed just to ensure that customers who are using our services are not underwriting the costs for customers who are not using our services," she said.

E*Trade spokeswoman Heather Fondo made similar remarks. "It's to help cover the costs associated with keeping accounts open and to deliver the same high service to our customers."

Neither companies' new fee applies to IRA accounts, which TD Waterhouse said was about one-third of its brokerage accounts, or to custodial accounts. It also won't apply to accounts that have been open for less than a year. Customers at both brokerages were notified this month.

Customers who don't like the new minimums can think about moving accounts, but if the trend continues, it won't do them much good for long.

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