As Zero Commission Trading Apps Grow Up, So Must their Users, Signaling Opportunity for Legacy Brokers

There’s a new kid on the block offering an addictive new substance. That substance is free access to stock trading for all. By offering free trading, app-based fintech startups aimed at getting a younger generation hooked on investing have made serious headway against traditional brokerages.

The trading app Robinhood, now some 6 million users strong, scaled rapidly by whittling commissions from between $5 and $8 a trade down to zero. And whether by onboarding an entirely new generation of investors or taking market share from incumbents, Robinhood took a bite out of their lunch. U.K.-based Freetrade and Revolut are doing the same across the pond, and are angling to bring their services to the U.S.

The digital upstarts are doing it again.

But as has been shown over and over in the digital world, innovators can only give things away for a limited period of time, before their funders demand to see profitability. While zero commissions appear to be the next innovative frontier, there must be a path to profitability. And there lies the opportunity for legacy companies to disrupt the disruptors. I’m reminded of something Marc Andreessen said: “The battle between every startup and incumbent comes down to whether the startup gets distribution before the incumbent gets innovation.” On these zero commission trading apps, the jury is still out.

It can be argued that this pattern of innovation really started in the 1970s, when the  U.S. Securities Acts Amendments of 1975  put a stop to fixed trade commissions and Charles Schwab introduced the discount brokerage model, enabling them to compete at a lower price point. Their play was incredibly successful: they quickly gained a huge volume of customers. Over time Schwab broadened their innovative approach beyond discount commissions, pumping hundreds of millions into new products, acquisition and distribution methods.

Eventually Schwab went from innovator to incumbent—and they, like TD Ameritrade and eTrade, appeared to lose relevance as startups rose. To better compete with the new providers, Interactive Brokers Group Inc.  recently introduced a service with commission-free trading called  IBKR Lite. This arguably normalized zero-commission trading even among legacy companies. When Schwab and TD Ameritrade made similar announcements, they, along with eTrade, took a hit on their stock price. Painful as this reset might seem, it’s a call to innovate.

Robinhood’s business model is to offer a core functionality for free and try to get to get as many people in the door with it as possible. The only way to make this free model work is by getting the high-volume distribution needed to make their business model commercially viable—before the incumbents can reinvent themselves. But I believe the incumbents can, and already are doing so. Take Schwab’s move, earlier this year, to offer a subscription model in lieu of a percentage of assets managed.

I’d posit that Robinhood’s true innovation was not zero-commissions, it was that heady combination of a supremely navigable mobile app, easy sign up and fast scaling through social sharing. What Robinhood did was take an existing business model and rebuild it, digitally, from the ground up, which allowed it to remove commission revenue without feeling the pain. Five years later, zero-commission is just table stakes. Robinhood also made investing more understandable to more people. Now kids in college with barely a balance in their savings account can invest, commission-free, in shares or fractional shares.

Once customers are in the virtual door, lured by zero commission, new app-based startups make their money by selling them additional services, utilities, or features—sometimes even pieces of core functionality you’d expect to be included. As with the Schwabs of this world, they can also make money on the spread between the interest they pay on customer deposits and the interest they charge on margin trading. And if their zero-commission model lies in batching trades together and executing them all at once, should a user want to execute a trade independently, they have to pay a fee for that. Some startups in the UK have even introduced a monthly paid subscription service that allows the user to “wrap” their investment in a tax-free vehicle such as a self-invested personal pension.

What about clients who don’t know much about investing? On top of the zero-commission startups, a new wave of apps such as Simply Wall Street and Genuine Impact are emerging—portals to data insights that aim to complement do-it-yourself trading. These new tools provide investors with much richer views into stocks—it’s not investment advice, per se, but guidance for new investors on navigating the process. These apps are arming do-it-yourself investors with more understanding so that they can make more informed decisions.

But perhaps that’s also where danger lies, and where there may be new opportunities for the legacies to innovate around the areas where they truly offer an advantage. Knowledge is not long-term strategy, which is where legacy companies continue to have an advantage. We live in an era where people at all stages are obliged to take ownership of their own financial futures.

But smart trading still requires a lot of understanding of the market beyond particular stocks, and it demands high levels of discipline. Sadly, many young people are buying on the basis of emotion rather than insights, acting on hearsay and fear of losing out. These realities may allow incumbents to go a level above DIY advice—not only by providing data, information and insights like these apps do, but also by offering proper investment advice, albeit in a low-cost, robo environment.

The skills these new investors need goes well beyond the slick mobile app that most 20 and 30 somethings so favor—they need to be protected from the severe, even fatal wounds that inexperienced DIY investors can inflict on themselves. After all, in a zero-commission world, investors probably only get what they pay for.

About the Author: Martijn Moerbeek is group director of Digital Strategy & Innovation at Legal and General, a forward-looking, UK-based financial services and insurance firm managing over $1.4 trillion in assets. He can be reached at [email protected].