Is free brokerage too good to be true? Here’s how stock brokers make money off you

Free brokerage is one of the key promises used by brokers to attract new clients. As one of the biggest costs of share trading, especially for prolific traders, this can sound appetising. But is this too good to be true? Yes and No.

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Free brokerage is only possible on some markets

Firstly, to be clear, there is no such thing as free brokerage on ASX shares. Some other global exchanges go so far as to pay investors to trade because they want trading volume – but not the ASX.

Now, CMC charges $0 for trades of $1,000 or less, but charges the greater of $11 or 0.10% of the trade for any order above that threshold. Otherwise, Stake’s offer of $3 per trade is as good as it gets. Secondly, even though brokerage may be free on other exchanges, there are other ways that brokers make money off you.

There’s such no thing as a free lunch

With the advent of online stock trading platforms, brokers now have the capability to offer free brokerage to their clients. But how exactly are these brokers able to operate with little or no transaction fees? It all boils down to the these brokers’ revenue model, which is quite different than traditional fee-based systems.

One of the ways that brokers make money while having free brokerage is by earning interest on uninvested cash balances that clients keep in their brokerage accounts. Once clients deposit money into their trading account, some of that amount may not be immediately invested. Brokers can then use that uninvested cash to purchase short-term assets like Treasury bills, earning interest on the processed transactions. Because the level of funds is high, brokers can receive significant returns through accumulation of small amounts.

Another method employed by brokers is by selling order flows to other firms, who use that flow to execute trades more efficiently and often at better prices. These firms are ready to pay for order flows as it provides them a market advantage, thereby creating a win-win situation for both the broker and the firm purchasing the order flow. However, this doesn’t mean the retail investor, i.e. you, gets the best price for his order!

Brokers may also price their additional services, such as  research, data analytics and investment advice as a way of generating revenue while having free brokerage. The brokers will charge separately for these services or package them with other offerings.

Do your research

It is crucial to understand the broker’s revenue model, fees and other terms and conditions before registering. A trading service with free brokerage may seem appealing to some investors, but it is essential to be informed of the entire deal … there is no such thing as a free lunch!

Researching different brokers thoroughly and comparing their fees and services is a sensible approach to take before committing to any broker. You might find our January 2023 article on the best trading platforms in Australia as a good place to start!

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