How does E*TRADE make money?

• Want to know how commission-free broker E*TRADE makes money?
• Review their various revenue streams and growth opportunities.
• See why Morgan Stanley acquired them in 2020.

Are you wondering how brokers make money even though they offer free trades? E*TRADE is one of the most established and well-known discount brokers and trading apps in the United States.

This article reviews their business model, their various revenue streams, and how they can grow the business in the future and differentiate themselves from other commission-free brokers.

What does E*TRADE do?

E*TRADE offers its clients commission-free trades and free bank accounts for retail investors. The company lets traders invest in a range of assets, from stocks to ETFs and CFDs.

After opening an account with E*TRADE, the firm upsells its clients to its range of products and services to enhance their trading and investing experience.

Some of the investment and trading opportunities sold by the firm include automated investments in ETFs, portfolio management, and IRAs.

How does E*TRADE work?

E*TRADE offers traders and investors a range of services and products, and they also have a fully functional trading platform available for retail traders. The company's brokerage accounts let traders process transactions commission-free, reducing trading costs for new traders trying to grow a small account.

E*TRADE also offers trading in options, futures contracts, and bonds for a nominal fee. The company's range of portfolio management services suits the risk appetites of both retail and institutional investors, with options for self-directed, automated, or fully managed accounts.

Clients can also link their savings and checking accounts to an in-house debit card and spend as they would with any other debit card facility.

The E*TRADE retirement accounts let users set up a self-directed or managed IRA, allowing for the self-management of IRA trades or the option of having a professional do it for you.

How E*TRADE makes money

E*TRADE makes money by offering discount brokerage services to traders and investors. The company uses a model generating income from payment for order flow and interest income it earns on the free float. E*TRADE invests its client funds into money market accounts to earn interest on the capital. The company also earns through margin rates charged on buying or shorting stocks on its platform.

Payment for Order Flow

As a zero-commission discount broker, E*TRADE sells its client order flow to high-frequency trading firms (HFTs). These HFTs stand between the user and the market, facilitating the order by acting as a "market maker." E*Trade receives a fraction of a penny per share as compensation for directing the order to the market maker.

The market maker adds liquidity to the market by facilitating trades. When the user clicks the "buy" or "sell" button, the HFT processes the trade, making a commission on the spread between the bid and ask. The HFT executes its trade at a fraction of a second.

All zero-commission brokers follow the same model, making it regulated normalcy in the market. E*TRADE is seeing great success with the model, generating $188 million in order flow revenue in 2019, and its client base continues to grow.

Interest income

E*TRADE also loans its client funds to banks and financial institutions, benefiting from interest charges on outstanding balances. According to data, E*TRADE makes over 60% of its revenues from interest on loans. In 2019, net interest income generated over $1.8 billion in revenues for E*Trade.

Commissions on trading

While E*TRADE offers commission-free trading on stocks and ETFs, it uses the payment for order flow model. However, the company also allows trading in options, bonds, and futures contracts at affordable rates.

E*TRADE claims the company made $421 million in net commissions for 2019, utilizing these asset classes. Traders pay for each time they place a trade using options, futures, or bonds, and there is no free model for this service.

Fees and service charges

E*TRADE makes the bulk of its money from the payment for order flow model and cash interest loans. However, the company also offers a range of portfolio management services, collecting management fees from its clients.

Portfolio management and retirement accounts (IRAs) are available through E*TRADE. The company earns income on these services through fees and service charges to the client. For managing retirement accounts, E*TRADE charges its clients a $25 fee for premature withdrawal, as well as excess contribution withdrawals, and any recharacterizations involving changing from traditional IRAs to Roth IRAs, and vice versa.

The company also makes money from margin trading services, where the users pay between 5.45% to 8.95% on the margin they use, depending on their debit balance in their trading account when placing the trade. If the trader holds a margin trade overnight, then E*TRADE charges interest on the margin loaned to the client.

Future growth engine

As of May 2020, Morgan Stanley, one of America's largest banking firms, concluded its acquisition of E*TRADE. Morgan Stanley acquired the firm in an all-stock deal, valued at $13 billion. The Wall Street Journal called the purchase the largest takeover since the days of the Great Recession.

Morgan Stanley's purchase shows that the banking industry sees electronic retail trading as a booming business for the next decade.

Post-merger, the company’s combined focus will be on three areas:

1. workplace wealth, which will combine E*TRADE’s U.S. stock plan business with Shareworks by Morgan Stanley, a public stock plan administration company,
2. digital banking, where E*TRADE is a leader in integration of brokerage accounts with checking and high-yield savings accounts, and
3. wealth management, where the relatively more stable wealth and investment management businesses are expected to contribute approximately 57% of the Firm’s pre-tax profits, more than double the contribution from a decade ago.

Competitors

As a leading fintech firm, E*TRADE faces stiff competition from other free trading apps and larger discount brokers. However, the company manages to remain relevant, seeing increasing user growth on its platform.

Some of the top competitors to E*TRADE include Robinhood, Fidelity, WeBull, TD Ameritrade, M1 Finance, and Charles Schwab.