Why SCB’s $10 Minimum Commission Makes Sense

The financial blogosphere buzzed with activity this week when Standard Chartered Bank (SCB) announced that they’ll be removing their famous “zero minimum commission” policy from their online trading platform. From 1 August 2016, they’ll be imposing a $10 per trade fee. Sad face. 🙁

What this means is that it no longer makes sense to invest in small amounts through SCB Online Trading. I won’t delve too much into this topic, because several bloggers have talked about it at length, including here, here, here, and here.

(Note: If you’re a member of my flagship course 80/20 Investing, you’ll get a follow-up guide on how to continue investing with SCB with this $10 commission in mind. Stay tuned!)

I’m not gonna lie – when I first heard the news, I was pissed. So like a keyboard warrior during the General Election, I sat down to write a huge diatribe railing against the greedy, money-grubbing brokerage industry.

But as I researched more, I realised that while it sucks to have to pay $10 every time I invest now, it actually makes sense. Here’s why.

How Minimum Commissions Work

To understand what a brokerage does, think about one of my favourite food delivery services: Food Panda.

Let’s say you’re craving for some 4Fingers (mmmm). You log on to Food Panda, place your order, and in 60 minutes, someone appears at your doorstep and gives you your food. AWESOME.

What you don’t notice is all the stuff that happens in the back-end: Food Panda processes your order and dispatches a delivery guy to 4Fingers. He flirts with the cashier, get slapped by the cashier, grabs your food, drives to your office, argues with the security guard, take the elevator up, and gives you your food.

Food Panda wants to discourage you from making small orders: It doesn’t make sense for them to go through all that trouble just to deliver, you know, one chicken wing. That’s why they impose a delivery fee, which applies regardless of whether you order $20 or $100 worth of finger-lickin’ goodness.

 

 

In the same way, when you place an “order” with your brokerage to buy shares, it costs them time and effort to match your order with someone else’s. They want to discourage you from making small, tentative, single-share trades (which can be tough to execute), which is why they charge a minimum commission – their “delivery fee” – for it.

I found out that even in the US – the world’s most competitive financial market – brokerages charge minimum commissions too. Here’s a comparison of a few of the big ones:

• TD Ameritrade: $9.99 USD
• Charles Schwab: $8.95 USD
• E*Trade: $9.99 USD
• Fidelity: $7.95 USD

Brokerages need to make money too. In 2014, a whopping 43.2 percent of TD Ameritrade’s revenue came from commissions and transaction fees.

People who whine that trading should be free are kind of like the weirdos who feel that the Singapore government should lower CPF contribution rates while simultaneously increasing retirement payouts. The numbers just don’t work out.

In other words, brokerages provide a service and charge money for it. Plain and simple. Until there’s a way for investors to trade directly with each other at zero cost, we’ll continue to have to use brokerages and pay their commissions.

If You Don’t Pay Commission, You’re Paying Something Else

But wait, how did SCB manage to offer zero minimum commission for the past couple of years?

Brokerages aren’t charities. If they’re offering something for free, they’re most likely making money off you somewhere else. In SCB’s case, they were probably scalping money off several other channels such as:

• Foreign exchange fees: For example, charging you to change money from SGD to USD to invest in US stocks. (SCB’s forex rates are notoriously horrible)
• Securities lending: Taking the stocks you bought, lending them to other investors who want to short them (i.e. betting that the stock will fall in price), and charging interest for it

The fact that SCB started charging a minimum commissions now indicates that this model is unsustainable in Singapore – at least for now. They probably couldn’t get enough business from these other channels to offset the costs of running a brokerage.

However, SCB isn’t the only one trying. US-based Robinhood and Hong Kong-based 8 Securities both proudly market themselves as zero commission brokerages. They also claim to make money from the same channels:

From Robinhood:

Robinhood makes money in many of the same ways as traditional online brokerages. These include:

• Collecting interest from customers who choose to upgrade to a margin account. We are testing margin in beta and will offer margin accounts later this year.
• Accruing interest from customers’ uninvested cash balances. It is important to note that our customers are not charged.”

From 8 Securities:

We will launch margin lending for active traders in the near future and we earn a little interest income on your cash deposits. It’s that simple.”

I want to believe their marketing stories, but I don’t completely buy it.

Firstly, their target market – millennials who want to invest in small amounts – aren’t likely to have piles of money sitting around in their brokerage accounts. They’re also not likely to engage in margin trading, given their inherent suspicion of the stock market from the Great Financial Crisis in 2008.

Next, in an environment of near-zero interest rates, it’s hard to imagine that brokerages can make that much money off investors’ uninvested cash balances. This article reported that Charles Schwab – which had more than 20B in cash balances – made just $600K in interest revenue in a quarter – a pitiful amount.

So how are Robinhood and 8 Securities really making money? It’s hard to tell.

At best, they’re burning through VC money and figuring things out as they go along. At worst, there are allegations that they’re engaging in some shady stuff like executing your order in “dark pools” or selling your data to HFT firms who use it to trade against you. I’m no expert at how brokerages work, but I do know that it has to be more than “We can charge $0 commission because we are just a mobile app lol”.

Until we have some real clarity on how these guys really make money, I’d prefer paying a $10 commission for something I understand instead of paying $0 commission and not being sure whether I’m getting screwed from behind.

Time For A Disruption

All this doesn’t change the fact that brokerages aren’t being nice to small investors. If you’re planning to invest only $100 a month, paying a $10-$30 minimum commission every time doesn’t really make sense.

In particular, Singapore has a looooooonnnngggg way to go with regards to improving our financial infrastructure.

A couple of years ago, I complained to someone who works for a Big Traditional Brokerage that their standard $25 minimum commission is simply way too high. He let slip that the Singapore brokerages have a “gentleman’s agreement” not to lower the commissions so that they don’t eat into each other’s profits.

Now that’s unacceptable. Firms collaborating (implicitly or explicitly) to screw consumers with high prices is just not cool.

So if SCB wants to charge a $10 minimum commission to keep themselves profitable – which is way lower than what other Singapore brokerages charge anyway – that’s fine by me. Anything to pressure these other dinosaur brokerages in Singapore to make them more competitive.

Having said that, maybe it’s time to rethink the brokerage model. In The Innovator’s Dilemma, Clayton Christensen talked about how new, disruptive companies succeed because they help create new markets that were previously ignored by the incumbents.

There’s already a new market in place: Young, tech-savvy investors who want a cheap, no-frills, low-maintenance way of investing.

We hate annoying financial advisors who’re only interested in selling us products we don’t need. We don’t trust fancy reports from the banks or brokerage houses. We don’t even need cool charting tools because we know that trading is a recipe for disaster.

Would this new market be served by a robo-advisor, a transparent zero-commission broker, or something completely different?

I don’t know the answer, but the company (or person) who can figure it out will become really, really rich.

Now, I want to hear from you: Is SCB’s new minimum commission justified? Why? Let me know in the comments below.

 

Image credit: victorcamilo, J. Walker-Yung, las – initially, Tsahi Levent-Levi