Irrespective of whether you are an experienced trader or new to capital markets, I am sure you would have heard of stock brokers. However, you probably don’t know how they make their money, besides the trading fees and commissions. Stock brokers are known to be rich, but what are the reasons behind it?
Stock brokers are rich because they have a diversified set of revenue streams. In addition to the trading fee and commission that brokers charge, they make money from additional revenue streams that include – premium services, referral bonuses, interest income, order flow payment, etc.
The rest of this article will elaborate more on what stock brokers do and why they are rich.
IMPORTANT SIDENOTE: I surveyed 1500+ traders to understand how social trading impacted their trading outcomes. The results shocked my belief system! Read my latest article: ‘Exploring Social Trading: Community, Profit, and Collaboration’ for my in-depth findings through the data collected from this survey!
Table of Contents
What Stock Brokers Do?
Stock brokers can be individuals or firms, but they all act as middlemen in the stock market. They take buy-or-sell orders from clients and find matching orders that will allow completion of the sale or purchase at the best possible price. Trades, therefore, proceed smoothly even though neither buyer nor seller has information about each other.
Other than trading, stock brokers offer a variety of services, especially the full-service brokers. With them, they provide other services like portfolio management, estate planning, and tax consulting. They also provide access to many accounts such as mutual funds and tax-favored retirement accounts, news on the market, real-time price quotes, and different level accounts with a range of benefits such as premium accounts.
When thinking of stock broker types, there in essence are three types – discount brokers, full-service brokers, and Robo-advisors. Of these, Robo-advisors are a new class of stock brokers.
Discount brokers buy and sell stocks for their clients but do not offer advice. Hence, they are also cheaper than full-service stock brokers.
The Robo-advisor stock brokers offer portfolio management services and automate investment and trading function for clients. They are more affordable than full-service brokers and allow clients to invest in a small set of portfolios but, they lack a human-advisor to guide you through your investment.
Here is a video on how to become a qualified stock broker:
Why Stock Brokers Are Rich?
Stock brokers make money in different ways and may vary among discount brokerages, Robo advisors, and full-service brokerages. However, even though you can trust a broker with your investment, they are also salespeople who earn a living from it. According to the US Bureau of Labor Statistics, the average stock broker earns a median income of around $71,720 as of 2012. However, the case is different depending on individuals and states.
Stock brokers will be rich if they have active traders—the following ways of making money contribute to the reasons why stock brokers are rich.
10 Ways Stock Brokers Make Money
Commissions
stock brokers make a small commission for every trade you place. For very active traders who place large volumes of trades, this may turn out to be a lot. Depending on your investment style and the brokerage account you choose, percentage commissions will vary. For active traders, commissions for every trade may be lower than those of buy-hold traders. Stock brokers who are successful in attracting more active traders are richer.
Broker Fees and Costs
There are many fees associated with hiring a stock broker, especially when you open a brokerage account with them. Some of these include:
- Minimum deposits – Many stock brokers will require that you pay a minimum deposit when opening a brokerage account with them. Similar to a bank account, you will need money every time you need to make a trade. On average, you will pay between 500 and 2500 dollars as a minimum deposit, but it can go up to 10,000 dollars.
- Trading fees – If you give your broker the authority to buy and sell trades for you, then they will require that you pay trading fees for these services. Other than executing trades, stock brokers are financial planners and money managers who will develop investment strategies for your portfolio.
- Inactivity fees – If you go for a long time without executing any trades, some brokers will charge inactivity fees. For some, if your account dips below a particular amount or level, they will charge a minimum balance fee.
- Software fees – Many stock brokers will not charge you to use their software. However, they will charge annual operating and maintenance fees.
Order Flow Payments
There are multiple markets that your brokerage has to choose from when you place a trade. These markets have prices that vary in small timescales; therefore, your brokerage takes a small risk. Other brokerages will use internalizers who act as middlemen between public markets and brokerages to avoid this risk. Brokerages will earn a minor revenue when they route investor’s orders through internalizers.
Interest Income
If some of the funds in your brokerage are held in a cash account or money market fund, your stock broker will likely invest it in other areas such as business instead of letting it sit in the accounts. You will earn a little interest from that, but they will make much more, hence why they are rich. The chances are that the 0.25 percent you will earn as interest is your broker’s return on profits.
Stock brokers generate a lot of revenue from idle money. When clients have held up stock, brokers can lend it to those who want to sell it short and earn interest from it; a process called stock loaning or share lending.
Churning
Stock brokers get paid commissions according to their trades; hence some may act as salesmen and peddle their firm’s investment products. If you are a beginner, it may prove challenging to choose between full-service and discount brokerages. Discount traders will not be expensive because they don’t offer advice, but you get what you pay for.
On the other hand, while full-service brokers offer the best services at high commissions, some will perform or encourage you to carry out many unnecessary trades that will eat into your investment and potentially result in loss of funds.
Complex Fees Structures
One of the ways brokers get rich is by complicating their fee structures so that you don’t know what you will be paying for. They will entice investors with a few incentives while not informing them of additional fees to be paid. While this is a wrong method, it is one of the ways some brokers attract investors to increase their commissions and referral bonuses.
It is necessary to beware of all the fees you will be paying and be cautious of unusual fee structures.
Referral Bonuses
Sometimes brokerage firms will want to encourage people to invest with them and buy into their firms. Part of what makes up brokers’ wealth is the referral fees offered to them when they sign up new investors. The higher the number of investors they sign up, the higher their referral bonuses.
Premium Services
Stock brokers offer other services other than executing trades, including giving you access to research tools and advice from professionals. Every time you request them, you are most likely being charged. These services will help in making better trades but will end up costing you a lot of money for a few minutes of service.
Trading Against Their Traders
Stock brokers can predict when their traders will place losing trades. Other times traders will directly accomplish an order instead of executing it on the open market. In this case, although rare, the brokers will place trades against them to earn the money that their clients lost.
Mutual Fund and ETF Offerings
Brokerages, in a bid to offer a one-stop-environment, will create mutual funds and ETFs. When clients invest their proceeds in them, they earn revenue from the commission. They also earn from money charged as exchange fees from these funds.
Author’s Recommendations: Top Trading and Investment Resources To Consider
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- Best Broker For Trading Success: I reviewed 15+ brokers and discussed my findings with 50+ consistently profitable traders. Post all that assessment, the best all round broker that our collective minds picked was M1 Finance. If you are looking to open a brokerage account, choose M1 Finance. You just cannot go wrong with it! Click Here To Sign Up for M1 Finance Today!
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Conclusion
Stock brokers are rich because of the methods they use to generate revenue. These include commissions, broker fees, referral bonuses, premium services, order flow payments, and offerings from mutual funds and ETFs.
The success of a brokerage depends on the number of investors and active stock traders. Some brokers will use other methods such as churning, using complex fee structures, and trading against clients to earn higher commissions and attract new client traders using a few incentives.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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