How does TD Ameritrade make money?

• Interested in how TD Ameritrade makes money despite charging no trading commissions?
• Learn why Charles Schwab acquired TD Ameritrade.
• Check out who TD Ameritrade competes with.

Are you looking to start trading? TD Ameritrade is one of America's largest discount brokers, offering trading solutions in various markets. This article explains how this firm makes money.

TD Ameritrade might offer commission-free trading, but the trader pays for that privilege with a slew of behind-the-scenes practices.

The company earns through its discount brokerage and through its fully-managed advisory and broker service. In fact, the business model is so lucrative that in 2020, Charles Schwab acquired the company, creating a market giant.

What does TD Ameritrade do?

TD Ameritrade is a "discount" brokerage, offering services to traders that want to self-direct their trading experience in the markets. Founded by John Joseph Ricketts in 1971, TD Ameritrade is one of the industry pioneers and one of the first firms to offer commission-free trading in the wake of the success of the trading app Robinhood.

TD Ameritrade started its online trading division in 1994 as an online platform connecting traders to the stock, forex, options, and futures markets. Users also have the option of trading commodities, forex, crypto, and mutual funds in their portfolios.

TD Ameritrade is one of America's largest discount brokers, with millions of active traders. It also offers advisory services for clients and full-service brokerage features for select clients. In 2020, TD Ameritrade had over $1 trillion in assets under management, with the company earning significant revenues from cash loans made against funds sitting in investors' accounts.

How does TD Ameritrade work?

During the 1970s, the trading world turned on its head after the announcement by the SEC eliminating fixed commissions charged by brokers. Then operating as Omaha Securities, TD Ameritrade was one of the first firms to step outside of the traditional broker model to offer discounted commissions on trades, leading to the founding of the "discount broker" market.

With discount brokers, traders could sidestep the need for getting a broker to place the trade for them, reducing their trading costs. The company was also the first to institute touch-tone trading over the phone in 1988 and other major industry innovations at the time.

In 1996, TD Ameritrade executed the very first online trade after acquiring the broker K. Aufhauser & Co. For the duration of the 1990s, TD Ameritrade focused its business on providing online trading portals for self-directed retail investors looking to manage their trading experience themselves.

TD Ameritrade is still at the forefront of the discount broker community some two decades later, with over 11 million client accounts on its platform.

Starting with TD Ameritrade is easy. The company works with US-based traders, and it also provides services to traders in over 100 countries internationally. To start, you'll need to open an account and fund it. TD Ameritrade doesn't have a minimum deposit requirement. However, if the trader wants to open a margin account, they'll need a minimum starting balance of $2,000.

How TD Ameritrade makes money

TD Ameritrade makes money by offering its clients a range of trading services. To support commission-free trading, TD Ameritrade generates revenues through payment for order flow, investment advisory fees, commissions on futures and options, net interest margin, and management fees.

Payment for order flow

The first income model employed by TD Ameritrade is its "Payment for order flow." Essentially, TD Ameritrade works with high-frequency trading firms (HFTs), routing all its client transactions through the HFT before they reach the market.

The HFT arbitrages the spread on the bid and asks, making fractions of a cent on each trade it processes. These HFT trades occur over nanoseconds, and they don't affect the trader's entry or exit from the position.

Essentially, the HFT provides "liquidity" to the market, and they pay TD Ameritrade a commission for sending them the order flow. There are many ethical compromises using this model, and some traders say they would rather pay commission than use a commission-free broker like TDA.

The commission fees earned are fractions of a cent. However, with the firm processing millions of trades in a day, the commissions add up.

Investment platform

TD Ameritrade offers an investment platform for self-directed trading with no commissions. However, the company does operate a traditional phone-your-broker model, allowing investors to call in and place a trade with their broker. The fees on this facility are between $5 to $25, depending on the level of broker involvement in the transaction.

The company also charges fees for options trading at $0.60 per contract, and futures contracts are available at the cost of $2.25 per contract. Traders must also pay exchange fees.

Net interest margin

In 2020, TD Ameritrade had over $1 trillion in assets, making it one of the largest discount brokers in the world. However, the company also makes money by leveraging the cash value of its client accounts.

TDA loans money to financial institutions, taking interest payments on outstanding loans. It creates profit on the net interest margin of the loan, making around 28% of its income from this model.

Future growth engine

As one of the leaders in the discount trading space, TD Ameritrade is constantly keeping up with changing market trends. Its adoption of commission-free trading occurred shortly after the announcement of Charles Schwab going in the same direction.

TDA aims to draw more traders to its platform by offering advanced charting packages and a range of useful services to traders. The 2020 acquisition of TD Ameritrade by Charles Schwab for $22 billion in an all-stock deal saw the company massively increase its user base.

When the deal closed in October 2020, the combined entity had a total of $6 trillion in assets under management, with more than 28 million brokerage accounts under its umbrella. The company aims to continue its transformation of the retail trading space, offering its clients services and solutions for navigating the markets.

According to senior management, the company intends to deliver a winning combination of low cost, industry-leading tech, and excellent customer service for clients and advisors.

Competitors

TD Ameritrade offers discount broker services and commission-free trading. Therefore, it's not a competitor to brokers like LightSpeed and Center Point that still charge commissions.

However, TDA is now targeting the millennial and Zoomer trading markets since this shows the greatest growth potential for the company. Other competitors in its space include brokers such as Fidelity, WeBull, Robinhood, E*TRADE, and M1 Finance.