How do brokerages make $s on cheap index funds?

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ChinchillaWhiplash
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How do brokerages make $s on cheap index funds?

Post by ChinchillaWhiplash » Sat May 05, 2018 9:07 am

Looking at fees charged by such firms as Schwab, I was wondering how they make any $s off them and why they even have them? For instance, Schwab has SWTSX or SCHB total market index funds. In Schwab account they have no load no fees with an ER = .03. Seems almost pointless from the aspect of making them money. I'm happy they have them, but what's in it for them (or any of the for profit brokerages that offer cheap funds like these)? Just curious.

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Re: How do brokerages make $s on cheap index funds?

Post by Silk McCue » Sat May 05, 2018 9:15 am

Apart from Vanguard the other firms offer a few low cost indexes to keep up with Vanguard and try to woo others to them in hopes they will invest in more profitable offerings. Vanguard isn't in business to make a profit, but rather to serve the interests of its owners (those of us that hold Vanguard funds) and thus they are the lost cost leader. Even in the actively managed funds Vanguard does this at lower expense than the competitors because they do not have a direct profit motive.

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Re: How do brokerages make $s on cheap index funds?

Post by livesoft » Sat May 05, 2018 9:17 am

0.03% is a awful big number when one is talking about a percentage of $500,000,00 to $5,000,000,000.
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Re: How do brokerages make $s on cheap index funds?

Post by Clever_Username » Sat May 05, 2018 9:20 am

They could be loss leaders -- you want a total market index fund, you see their house is 1 bp lower than Vanguard so you go there, then they can pitch you on managing your portfolio or selling you a different fund that they make a profit on.
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Re: How do brokerages make $s on cheap index funds?

Post by dbr » Sat May 05, 2018 9:25 am

A different answer is that they don't, which is why they have such a massive incentive to find ways to take people's money away in high ERs, loads, and management fees. It is surprising so few people recognize that the fundamental reason for being in business as a financial services company is to make money by taking it away from someone.

Also, no one should think that the employees at Vanguard are not paid for their work, some of them very well paid, though the data is hard to come by.

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Re: How do brokerages make $s on cheap index funds?

Post by deltaneutral83 » Sat May 05, 2018 10:51 am

Same concept as getting people to sign up for credit cards, the folks that pay off balances and churn are loss leaders. The folks that run balances and pay interest for decades pay the rewards to those that do not. For brokerages, for every ten people that sign up, I'd imagine at least 7 are trading single stocks or buying actively managed funds. It's also a point of vanity to say "We at brokerage ABC hold "X" amount in assets" insinuating that the more they hold the better they must be. They are happy to let a BH have a high 6 or 7 figure account with index funds because it boosts their tagline.

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Re: How do brokerages make $s on cheap index funds?

Post by Alexa9 » Sat May 05, 2018 10:54 am

It's a race to the bottom. Schwab and Fidelity are trying to keep up with the huge inflow to Vanguard. How else are they going to do it besides charge a practically insignificant basis point less?

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Re: How do brokerages make $s on cheap index funds?

Post by anil686 » Sat May 05, 2018 11:16 am

I agree with Livesoft on this. The fees generated for not having a highly skilled portfolio manager with those sums when you have a back office that can probably do everything else makes the fees nothing but profit for these companies. Sure, one can argue - how much profit - but it is a lot.

I remember this interview with Barry Ritholz and Liz Ann Sonders from Schwab
https://soundcloud.com/bloombergview/ch ... nders/sets

She described low cost investors (like many of us index investors) as not low cost, but rather long term buy and hold investors. It seems that Schwab and Blackrock both pivoted about the same time and used similar language to describe this set of investors as traditional buy and hold indexers that wanted low cost, broad market index funds. They described these investors as desirable because they kept their assets consistently in those funds (meaning dependable investors), kept assets in those funds due to cap gains in taxable accounts, did not need a lot of hand holding or marketing per se furthering the cost benefits, and and could provide a stable pool of investment assets. It was about that time in 2015 that both Schwab and Blackrock lowered fees with Blackrock starting the core ishares products with the very low ERs and Schwab with their low ER MF/ETF group. Not everybody has done it though - T Rowe Price and others still have relatively high indexed options. But I think with the large investment brokerages - they see the advantage of having lots of AUM at a low fee versus having to fight hard with extensive (and not guaranteed) marketing to get investors at a higher ER especially with the current fee pressures that exist.

JMO though...

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Re: How do brokerages make $s on cheap index funds?

Post by dbr » Sat May 05, 2018 11:22 am

anil686 wrote:
Sat May 05, 2018 11:16 am
I agree with Livesoft on this. The fees generated for not having a highly skilled portfolio manager with those sums when you have a back office that can probably do everything else makes the fees nothing but profit for these companies. Sure, one can argue - how much profit - but it is a lot.

I remember this interview with Barry Ritholz and Liz Ann Sonders from Schwab
https://soundcloud.com/bloombergview/ch ... nders/sets

She described low cost investors (like many of us index investors) as not low cost, but rather long term buy and hold investors. It seems that Schwab and Blackrock both pivoted about the same time and used similar language to describe this set of investors as traditional buy and hold indexers that wanted low cost, broad market index funds. They described these investors as desirable because they kept their assets consistently in those funds (meaning dependable investors), kept assets in those funds due to cap gains in taxable accounts, did not need a lot of hand holding or marketing per se furthering the cost benefits, and and could provide a stable pool of investment assets. It was about that time in 2015 that both Schwab and Blackrock lowered fees with Blackrock starting the core ishares products with the very low ERs and Schwab with their low ER MF/ETF group. Not everybody has done it though - T Rowe Price and others still have relatively high indexed options. But I think with the large investment brokerages - they see the advantage of having lots of AUM at a low fee versus having to fight hard with extensive (and not guaranteed) marketing to get investors at a higher ER especially with the current fee pressures that exist.

JMO though...
And to add to this is the whole market for institutional funds offered in 401k's. At my employer there was early on an S&P 500 index fund from SSgA that had a 0.01% ER. We even had someone on this board report an S&P 500 offering at 0.00% ER. There is still obviously a business out there for this.

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Re: How do brokerages make $s on cheap index funds?

Post by TigerNest » Sat May 05, 2018 11:31 am

One small way they generate additional money is by lending shares to short sellers.

When someone sells a stock short, they have to borrow it from somewhere beforehand. Index funds often lend shares out and receive a small fee while doing so.

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Re: How do brokerages make $s on cheap index funds?

Post by sport » Sat May 05, 2018 12:15 pm

If we want an estimate of the costs associated with operating a large index fund, all we need do is look at Vanguards published ERs. Since V operates at cost, those are the costs. For any other company offering comparable ERs, there cannot be much if any profit to be made. If there were, V would have even lower ERs. The only way this would not be true would be if the other companies operated more efficiently than V. However, since they have B&M offices and people staffing them, this is hardly likely. It certainly cannot be due to economies of scale.

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Re: How do brokerages make $s on cheap index funds?

Post by Spirit Rider » Sat May 05, 2018 12:42 pm

Before fans get all warm and misty-eyed over the operating structure of Vanguard. How about some facts, instead of bogus speculation about loss leaders, etc...

Fidelity index funds (with the exception of FFNOX) have been fully profitable for over a decade. Before that Fidelity did subsidize them. This was the basis for the common refrain from Vanguard fans and I hear the same FUD against Schwab now. "Don't use Schwab and Fidelity before them, because once they get you, the big bad wolf is going to raise the expense ratios." There is a very simple reason that it didn't happen with Fidelity and won't happen with Schwab.

It is called capitalism. You know that thing we invest in. Plain and simple market competition is what drives prices. Time and time again commercial companies have been able to be competitive or even less expensive than co-ops, mutual companies, etc... This is because the profit motive itself is what drives innovation and efficiencies.

sport: Commercial companies can and do offer lower prices and still generate profit margins for their owners. The fact that Vanguard doesn't have to make a profit can allow it to operate with inefficiencies, This has always been a factor in customer owned enterprises.

Look, I think that Jack Bogle and Vanguard should be commended for the great service they have and continue to give to individual investors. However, emotional attachment and blind loyalty are fundamental behavioral finance errors.

I still think that Vanguard has an advantage for taxable accounts, but Fidelity and Schwab are competitive options and may have a slight advantage for IRAs.

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Re: How do brokerages make $s on cheap index funds?

Post by Earl Lemongrab » Sat May 05, 2018 1:14 pm

Just because company A runs at cost that doesn't mean that they run at the minimum possible cost. As I've said before, if the non-profit model always presented the cheapest price to consumers, such companies would dominate all aspects of the economy. When is the last time you bought groceries at a non-profit supermarket?
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Re: How do brokerages make $s on cheap index funds?

Post by bberris » Sat May 05, 2018 1:16 pm

sport wrote:
Sat May 05, 2018 12:15 pm
If we want an estimate of the costs associated with operating a large index fund, all we need do is look at Vanguards published ERs. Since V operates at cost, those are the costs. For any other company offering comparable ERs, there cannot be much if any profit to be made. If there were, V would have even lower ERs. The only way this would not be true would be if the other companies operated more efficiently than V. However, since they have B&M offices and people staffing them, this is hardly likely. It certainly cannot be due to economies of scale.
There is not any requirement that Vanguard operate at cost. There is clearly a gross profit margin in running vanguard's low-cost index funds. Non-profit is a legal and tax arrangement. Non-profits call their profits "retained earnings" or reserves or something. They could really charge whatever the market will bear and distribute as salaries.
Vanguard's CEO was making 15 million at last count.

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Re: How do brokerages make $s on cheap index funds?

Post by Eric » Sat May 05, 2018 1:48 pm

livesoft wrote:
Sat May 05, 2018 9:17 am
0.03% is a awful big number when one is talking about a percentage of $500,000,00 to $5,000,000,000.
The math looks worse at the individual account level, especially for small accounts. Schwab is grossing $3 on a $10,000 account. Surely it's losing money on those accounts, and hoping to make it up elsewhere (either on larger accounts or other products).

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Re: How do brokerages make $s on cheap index funds?

Post by Earl Lemongrab » Sat May 05, 2018 2:17 pm

Eric wrote:
Sat May 05, 2018 1:48 pm
The math looks worse at the individual account level, especially for small accounts. Schwab is grossing $3 on a $10,000 account. Surely it's losing money on those accounts, and hoping to make it up elsewhere (either on larger accounts or other products).
An Vanguard isn't grossing much more. Do you think Vanguard manages portfolio services much cheaper?
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Re: How do brokerages make $s on cheap index funds?

Post by Eric » Sat May 05, 2018 2:19 pm

Earl Lemongrab wrote:
Sat May 05, 2018 2:17 pm
Eric wrote:
Sat May 05, 2018 1:48 pm
The math looks worse at the individual account level, especially for small accounts. Schwab is grossing $3 on a $10,000 account. Surely it's losing money on those accounts, and hoping to make it up elsewhere (either on larger accounts or other products).
An Vanguard isn't grossing much more. Do you think Vanguard manages portfolio services much cheaper?
No, I also think Vanguard is losing money on these small accounts and making it up elsewhere. I wasn't making a negative point about Schwab, just commenting on the OP's question about the economics of these accounts.

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Re: How do brokerages make $s on cheap index funds?

Post by whodidntante » Sat May 05, 2018 2:26 pm

Order flow, securities lending, fees for other things you might do, and the fact that their customers stay instead of boarding a ship.

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Re: How do brokerages make $s on cheap index funds?

Post by jminv » Sat May 05, 2018 2:34 pm

While 0.03% does seem too low even with scale it also misses the other more lucrative income that schwab, for example, can earn just from the etf and it’s holdings. Schwab can and does engage in securities lending with the underlying securities in the etf to, for example, short sellers. This brings in non-trivial sums. It is, in fact, because of this income stream that the race to the bottom in Etf fees will hit 0% (and could actually go slightly negative).

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Re: How do brokerages make $s on cheap index funds?

Post by MnD » Sat May 05, 2018 3:11 pm

Places like Schwab want the haystack in terms of all your families financial assets.
When its all sorted out they make plenty of money - check out their stock price lately.

A selective consumer can do incredibly well at brokerages like Schwab with their index ETF's and Funds and things like their checking account. Likewise with other top-tier financial providers like with Chase credit cards if you are savvy about the sign-on bonuses, optimizing usage rewards and never carry over a balance.

I'm quite familiar with the costs and services provided by Vanguard and they aren't even remotely competitive with Schwab given our households utilization of bank and brokerage services. I do agree that unsophisticated users of financial services provide a large and ongoing subsidy for those that know what they are doing - but what's new.

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Re: How do brokerages make $s on cheap index funds?

Post by Earl Lemongrab » Sat May 05, 2018 3:19 pm

MnD wrote:
Sat May 05, 2018 3:11 pm
Places like Schwab want the haystack in terms of all your families financial assets.
I'm not sure what this means. I have held my investments at various brokerages. Never once has one requested or even expressed an interest in anything else.
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Re: How do brokerages make $s on cheap index funds?

Post by msi » Sat May 05, 2018 3:36 pm

They want you to have a cash balance with them somewhere, so they can profit off the difference between the low rate they pay and the high rate they earn themselves on your money. It could be a checking account they entice you to use with benefits in lieu of a decent interest rate, your sweep account, cash allocation in a fund, etc.

Schwab actually earns more from this than they do advisory fees or anything else http://pressroom.aboutschwab.com/press- ... ps-record- and scroll down to "net interest revenue."

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Re: How do brokerages make $s on cheap index funds?

Post by Clever_Username » Sat May 05, 2018 4:21 pm

jminv wrote:
Sat May 05, 2018 2:34 pm
While 0.03% does seem too low even with scale it also misses the other more lucrative income that schwab, for example, can earn just from the etf and it’s holdings. Schwab can and does engage in securities lending with the underlying securities in the etf to, for example, short sellers. This brings in non-trivial sums. It is, in fact, because of this income stream that the race to the bottom in Etf fees will hit 0% (and could actually go slightly negative).
How would a negative ER even work? I'm having trouble picturing it.
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Re: How do brokerages make $s on cheap index funds?

Post by triceratop » Sat May 05, 2018 4:31 pm

bberris wrote:
Sat May 05, 2018 1:16 pm
sport wrote:
Sat May 05, 2018 12:15 pm
If we want an estimate of the costs associated with operating a large index fund, all we need do is look at Vanguards published ERs. Since V operates at cost, those are the costs. For any other company offering comparable ERs, there cannot be much if any profit to be made. If there were, V would have even lower ERs. The only way this would not be true would be if the other companies operated more efficiently than V. However, since they have B&M offices and people staffing them, this is hardly likely. It certainly cannot be due to economies of scale.
There is not any requirement that Vanguard operate at cost. There is clearly a gross profit margin in running vanguard's low-cost index funds. Non-profit is a legal and tax arrangement. Non-profits call their profits "retained earnings" or reserves or something. They could really charge whatever the market will bear and distribute as salaries.
Vanguard's CEO was making 15 million at last count.
What does a company's executive pay have to do with whether substantial profit-seeking is occurring rather than the benefits of lower costs being passed to shareholders in the form of lower fees?

The fact that they could do something does not mean that they in fact do this. Nor is it disproof that they run at-cost. There have been excellent plots made of AUM vs fees charged at Vanguard and the relationship is uncanny, providing clear proof of at- or nearly-at-cost products.
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Re: How do brokerages make $s on cheap index funds?

Post by Doom&Gloom » Sat May 05, 2018 4:45 pm

I let brokerages worry about their money. I worry about my own.

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Re: How do brokerages make $s on cheap index funds?

Post by Jack FFR1846 » Sat May 05, 2018 4:48 pm

I have to they're making money. 0.03% on $1M is $300 every year. What do they do? Post statements and 1099's? In 30 years, that's $9,000 collected.

Think if instead, someone bought $1M in a single stock and sat on it for 30 years. They make $4.95 on the buy and $4.95 on the sale. Less than ten bucks after the sale at the 30 year point.
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Re: How do brokerages make $s on cheap index funds?

Post by david1082b » Sat May 05, 2018 4:50 pm

Clever_Username wrote:
Sat May 05, 2018 4:21 pm
jminv wrote:
Sat May 05, 2018 2:34 pm
While 0.03% does seem too low even with scale it also misses the other more lucrative income that schwab, for example, can earn just from the etf and it’s holdings. Schwab can and does engage in securities lending with the underlying securities in the etf to, for example, short sellers. This brings in non-trivial sums. It is, in fact, because of this income stream that the race to the bottom in Etf fees will hit 0% (and could actually go slightly negative).
How would a negative ER even work? I'm having trouble picturing it.
It would use the income generated from lending shares to short-sellers (short sellers need to pay interest to the owners of the stock that they borrow). If the income gets high enough it could cancel out the management fees and then some, so the left-over money would go to the fund investors.

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Re: How do brokerages make $s on cheap index funds?

Post by MnD » Sat May 05, 2018 5:16 pm

Earl Lemongrab wrote:
Sat May 05, 2018 3:19 pm
MnD wrote:
Sat May 05, 2018 3:11 pm
Places like Schwab want the haystack in terms of all your families financial assets.
I'm not sure what this means. I have held my investments at various brokerages. Never once has one requested or even expressed an interest in anything else.
It refers to some published interviews with Schwab executives I recall. They indicated they wanted households to use them for all their financial services - that they were first and foremost asset gatherers for all types of accounts and services versus traditional brokerage services. Schwab offers banking, brokerage services, loans, credit cards etc. Some years back they dialed back the credit services. Schwab Bank itself used to offer home loans - now they are just a portal for Quicken loans. The old 2% back Schwab credit card wasn't issued through Schwab Bank, but it was a bigger play on branded credit card versus now.

But even today looking at fees schedules, minimums and overall depth and quality of of services it's clear to me that Schwab wants to be your financial supermarket and Vanguard doesn't.

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Re: How do brokerages make $s on cheap index funds?

Post by Spirit Rider » Sat May 05, 2018 5:45 pm

triceratop wrote:
Sat May 05, 2018 4:31 pm
bberris wrote:
Sat May 05, 2018 1:16 pm
sport wrote:
Sat May 05, 2018 12:15 pm
If we want an estimate of the costs associated with operating a large index fund, all we need do is look at Vanguards published ERs. Since V operates at cost, those are the costs. For any other company offering comparable ERs, there cannot be much if any profit to be made. If there were, V would have even lower ERs. The only way this would not be true would be if the other companies operated more efficiently than V. However, since they have B&M offices and people staffing them, this is hardly likely. It certainly cannot be due to economies of scale.
There is not any requirement that Vanguard operate at cost. There is clearly a gross profit margin in running vanguard's low-cost index funds. Non-profit is a legal and tax arrangement. Non-profits call their profits "retained earnings" or reserves or something. They could really charge whatever the market will bear and distribute as salaries. Vanguard's CEO was making 15 million at last count.
What does a company's executive pay have to do with whether substantial profit-seeking is occurring rather than the benefits of lower costs being passed to shareholders in the form of lower fees?

The fact that they could do something does not mean that they in fact do this. Nor is it disproof that they run at-cost. There have been excellent plots made of AUM vs fees charged at Vanguard and the relationship is uncanny, providing clear proof of at- or nearly-at-cost products.
The problem is your basic premise. Vanguard's costs are their costs, including senior executive salaries. It has been pointed out over and over again that mutual companies do not tend to operate as efficiently as for profit companies. You can deny this all you want, but it is the reality.

Otherwise mutual companies would always be able to price below for profit companies by their profit margin. Yet they don't. It is the same reason that regulated monopolies become inefficient. The have no profit motive to drive efficiencies.

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Re: How do brokerages make $s on cheap index funds?

Post by AlohaJoe » Sat May 05, 2018 7:05 pm

Eric wrote:
Sat May 05, 2018 1:48 pm
livesoft wrote:
Sat May 05, 2018 9:17 am
0.03% is a awful big number when one is talking about a percentage of $500,000,00 to $5,000,000,000.
The math looks worse at the individual account level, especially for small accounts. Schwab is grossing $3 on a $10,000 account. Surely it's losing money on those accounts, and hoping to make it up elsewhere (either on larger accounts or other products).
I doubt Schwab cares overly much about per account revenue, though. They make $17 million a year on their total market fund, just from ER. Throw in securities lending and maybe selling deal flow and I could see that going to maybe $25 million a year. I have to imagine that running a fund is a fairly scalable business, you don't have a lot of per account costs these days now that virtually everyone has dropped physical mailing of things.

I don't know how much their technical infrastructure and trading desk costs but it doesn't seem crazy to think that $25 million could be enough to run it.

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Re: How do brokerages make $s on cheap index funds?

Post by venkman » Sat May 05, 2018 8:27 pm

Eric wrote:
Sat May 05, 2018 2:19 pm
Earl Lemongrab wrote:
Sat May 05, 2018 2:17 pm
Eric wrote:
Sat May 05, 2018 1:48 pm
The math looks worse at the individual account level, especially for small accounts. Schwab is grossing $3 on a $10,000 account. Surely it's losing money on those accounts, and hoping to make it up elsewhere (either on larger accounts or other products).
An Vanguard isn't grossing much more. Do you think Vanguard manages portfolio services much cheaper?
No, I also think Vanguard is losing money on these small accounts and making it up elsewhere. I wasn't making a negative point about Schwab, just commenting on the OP's question about the economics of these accounts.
Vanguard charges a $20 annual fee for most accounts with a balance under $10k (They waive the fee if you agree to receive all your documents electronically.) Plus, if you have under $10k in any Vanguard fund, you're holding Investor-class shares that have a higher ER. I think they're pretty good about fairly distributing the cost of running things.

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Re: How do brokerages make $s on cheap index funds?

Post by inbox788 » Sat May 05, 2018 9:02 pm

venkman wrote:
Sat May 05, 2018 8:27 pm
Eric wrote:
Sat May 05, 2018 2:19 pm
Earl Lemongrab wrote:
Sat May 05, 2018 2:17 pm
Eric wrote:
Sat May 05, 2018 1:48 pm
The math looks worse at the individual account level, especially for small accounts. Schwab is grossing $3 on a $10,000 account. Surely it's losing money on those accounts, and hoping to make it up elsewhere (either on larger accounts or other products).
An Vanguard isn't grossing much more. Do you think Vanguard manages portfolio services much cheaper?
No, I also think Vanguard is losing money on these small accounts and making it up elsewhere. I wasn't making a negative point about Schwab, just commenting on the OP's question about the economics of these accounts.
Vanguard charges a $20 annual fee for most accounts with a balance under $10k (They waive the fee if you agree to receive all your documents electronically.) Plus, if you have under $10k in any Vanguard fund, you're holding Investor-class shares that have a higher ER. I think they're pretty good about fairly distributing the cost of running things.
These small accounts are all going to be money losers for all the brokerages, but how are they ever going to grow accounts if they don't? It's like the seed business, a lot of seeds don't sprout, and some of the sprouts don't grow big enough to cash out, but once a certain percentage of the seeds grow into big enough plants or trees, there's more than enough money made to pay for the failed seedlings.

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Re: How do brokerages make $s on cheap index funds?

Post by Nate79 » Sat May 05, 2018 9:11 pm

Its readily apparent that most in this thread haven't read the annual reports for the funds they are talking about. All the fees the funds incur as well as income are listed out in detail for Vanguard, Schwab, etc. The biased pro Vanguard vs Schwab and others is quite apparent in the rhetoric that is repeated over and over in this topic.

I do not believe Schwab is falsifying their annual reports and reported expenses that the funds are actually incurring. In fact their annual reports do list a fee reduction subsidy which is extremely small and would not change the ER. I believe Schwabs reported ER just as much as I believe Vanguards.

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Re: How do brokerages make $s on cheap index funds?

Post by michaeljc70 » Sun May 06, 2018 12:04 am

Earl Lemongrab wrote:
Sat May 05, 2018 1:14 pm
Just because company A runs at cost that doesn't mean that they run at the minimum possible cost. As I've said before, if the non-profit model always presented the cheapest price to consumers, such companies would dominate all aspects of the economy. When is the last time you bought groceries at a non-profit supermarket?
When I was in public accounting, my firm audited a lot of not for profits. They are generally way less efficient than for profit enterprises. For profit companies are accountable to shareholders. Not for profit, in theory, are accountable to donors. However, it is definitely a different level of accountability.

I worked at a not for profit hospital in college 4 days a month. They gave me vacation time!

ThrustVectoring
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Re: How do brokerages make $s on cheap index funds?

Post by ThrustVectoring » Sun May 06, 2018 2:43 am

The cheap index funds are at cost offerings to bring people onto the platform. Fidelity offers 401(k) plans and presumably charges either plan operators or participants for this, and they need to have cheap index funds in order to be competitive. Also there's uninvested cash balances, and they can pocket the difference between interest earned vs charged. Plus, managing a cheap index fund is cheap, you don't need many people to manage it.
Current portfolio: 60% VTI / 40% VXUS

lazyday
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Re: How do brokerages make $s on cheap index funds?

Post by lazyday » Sun May 06, 2018 4:27 am

jminv wrote:
Sat May 05, 2018 2:34 pm
Schwab can and does engage in securities lending with the underlying securities in the etf to, for example, short sellers. This brings in non-trivial sums.
https://www.schwabfunds.com/public/file/P-7549969 pdf
...100% of securities lending revenues, net of total costs and expenses, are returned to the participating funds.

lazyday
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Re: How do brokerages make $s on cheap index funds?

Post by lazyday » Sun May 06, 2018 4:37 am

anil686 wrote:
Sat May 05, 2018 11:16 am
Liz Ann Sonders from Schwab
https://soundcloud.com/bloombergview/ch ... nders/sets

She described low cost investors (like many of us index investors) as not low cost, but rather long term buy and hold investors. .... did not need a lot of hand holding or marketing ... and could provide a stable pool of investment assets
So we help build an economy of scale!

Schwab still probably loses money on Bogleheads, but maybe we aren't quite the "devil customers" I've imagined.

confusedinvestor
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Re: How do brokerages make $s on cheap index funds?

Post by confusedinvestor » Sun May 06, 2018 2:04 pm

+1
and, there is no CAP in ER accrued fess for AUM per Account/Family for WholeSalers (eg Schwab, Fido, Vanguard too...)
livesoft wrote:
Sat May 05, 2018 9:17 am
0.03% is a awful big number when one is talking about a percentage of $500,000,00 to $5,000,000,000.

MrPotatoHead
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Re: How do brokerages make $s on cheap index funds?

Post by MrPotatoHead » Sun May 06, 2018 3:35 pm

Silk McCue wrote:
Sat May 05, 2018 9:15 am
Vanguard isn't in business to make a profit, but rather to serve the interests of its owners (those of us that hold Vanguard funds) and thus they are the lost cost leader. Even in the actively managed funds Vanguard does this at lower expense than the competitors because they do not have a direct profit motive.

Cheers
LOL...gosh you are killing me. That adults actually believe this fairy tale. So by this logic I should really be loving on my USAA insurance... But, whatever it takes you to get through the day...

And this is not mean to be snarky, just more like I am stunned every time I see it. But I get it, we all have to believe in something. I am partial to the flying spaghetti monster myself.

Others have posted some of the reason way I say this...but I'll just mention, you can find many books explaining how you can rich starting your own no-profit.

SlowMovingInvestor
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Re: How do brokerages make $s on cheap index funds?

Post by SlowMovingInvestor » Sun May 06, 2018 3:39 pm

One thing worth pointing out is that Vanguard's money market funds have the highest yields (and lowest expense ratios) by around 30 basis points for individual class funds. Fidelity, Schwab etc. are worse, and TDAM is much, much worse.

Why would other companies be able/willing to beat Vanguard on it's headline index funds expense ratios, but not on money market funds if they could make a profit doing so ? Why is their supposed greater efficiency not applicable to MM funds ?

I suspect that they are subsidizing some of their cheapest funds internally, and really -- internal accounting and cost sharing can be easily modified to subsidize these funds.

SlowMovingInvestor
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Re: How do brokerages make $s on cheap index funds?

Post by SlowMovingInvestor » Sun May 06, 2018 3:41 pm

Doom&Gloom wrote:
Sat May 05, 2018 4:45 pm
I let brokerages worry about their money. I worry about my own.
The reason we should be mildly concerned is that if these funds/ETFs are loss leaders, brokerages could raise fees and those of us with large unrealized gains in taxable might find it hard to switch to lower cost funds.

Note -- I said 'mildly'.

Silk McCue
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Re: How do brokerages make $s on cheap index funds?

Post by Silk McCue » Sun May 06, 2018 4:09 pm

MrPotatoHead wrote:
Sun May 06, 2018 3:35 pm
Silk McCue wrote:
Sat May 05, 2018 9:15 am
Vanguard isn't in business to make a profit, but rather to serve the interests of its owners (those of us that hold Vanguard funds) and thus they are the lost cost leader. Even in the actively managed funds Vanguard does this at lower expense than the competitors because they do not have a direct profit motive.

Cheers
LOL...gosh you are killing me. That adults actually believe this fairy tale. So by this logic I should really be loving on my USAA insurance... But, whatever it takes you to get through the day...

And this is not mean to be snarky, just more like I am stunned every time I see it. But I get it, we all have to believe in something. I am partial to the flying spaghetti monster myself.

Others have posted some of the reason way I say this...but I'll just mention, you can find many books explaining how you can rich starting your own no-profit.
Thanks for the mocking and misconstrued reply. Doing so certainly added to the conversation immensely and was certainly a benefit to the OP. You are to be commended.

Cheers

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willthrill81
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Re: How do brokerages make $s on cheap index funds?

Post by willthrill81 » Sun May 06, 2018 4:24 pm

Sometimes, they make money by charging fees on the accounts in which the 'cheap' index funds are held. For instance, my 457 plan has access to a large cap index fund by Blackrock. The expense ratio is .003%, less than one-third of one basis point. That's practically nothing; for every $1 million in this fund, the expense is just $30 annually. For every billion dollars in this fund, they would only generate $30,000 of fees, an absolute pittance and nowhere near enough to keep any organization, even a non-profit, afloat.

How are they able to make money in this way? By charging the plan provider fees for administration of the account.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Doom&Gloom
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Re: How do brokerages make $s on cheap index funds?

Post by Doom&Gloom » Sun May 06, 2018 5:27 pm

SlowMovingInvestor wrote:
Sun May 06, 2018 3:41 pm
Doom&Gloom wrote:
Sat May 05, 2018 4:45 pm
I let brokerages worry about their money. I worry about my own.
The reason we should be mildly concerned is that if these funds/ETFs are loss leaders, brokerages could raise fees and those of us with large unrealized gains in taxable might find it hard to switch to lower cost funds.

Note -- I said 'mildly'.
Thanks for the 'mildly.' I would consider that concern to be part of my worrying about my money. Perhaps a semantic difference due to one's perspective?

My broader point is that I worry about what I can control. There is presently competition with brokerage fees--very unlike the fixed brokerage fees when I began investing in the '70s. Expenses matter--a lot. I shop accordingly--and am not concerned with trying to peek behind the curtains of how companies manage to exist. I assume they are able to exist because they are not losing money.

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Re: How do brokerages make $s on cheap index funds?

Post by Nate79 » Sun May 06, 2018 5:34 pm

SlowMovingInvestor wrote:
Sun May 06, 2018 3:39 pm
One thing worth pointing out is that Vanguard's money market funds have the highest yields (and lowest expense ratios) by around 30 basis points for individual class funds. Fidelity, Schwab etc. are worse, and TDAM is much, much worse.

Why would other companies be able/willing to beat Vanguard on it's headline index funds expense ratios, but not on money market funds if they could make a profit doing so ? Why is their supposed greater efficiency not applicable to MM funds ?

I suspect that they are subsidizing some of their cheapest funds internally, and really -- internal accounting and cost sharing can be easily modified to subsidize these funds.
Maybe Vanguard's MM funds are loss leaders just like what you are claiming is being done by other firms? Why is it that other firms are wolves in sheep clothing and Vanguard only rides in on a white horse?

Most of this thread is speculation and fantasy.

retiringwhen
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Re: How do brokerages make $s on cheap index funds?

Post by retiringwhen » Sun May 06, 2018 5:38 pm

Silk McCue wrote:
Sat May 05, 2018 9:15 am
Vanguard isn't in business to make a profit, but rather to serve the interests of its owners (those of us that hold Vanguard funds) and thus they are the lost cost leader. Even in the actively managed funds Vanguard does this at lower expense than the competitors because they do not have a direct profit motive.

Cheers
Non-snarkily, the idea that the profit motive is a driver for lower costs has been shown to false many many times. I worked for a company in telecom (as an R&D arm for the Baby Bells) that was organized very similarly to Vanguard and it was anything but efficient. There are some terribly run mutually owned insurance companies and credit unions too. In other words, if you are buying from a non-profit make sure you benchmark the product's price with the market-place to ensure it is at least competitive.

With that said, the owner relationship, if truly functioning (and that is not always true), in mutual organizations does have the tendency to align customer/owner and the company's interests. This means, that normally the organization will stay focussed on its mission and not look to "harvest" from their owners. That is the core reason why Vanguard owns the moment today. It's fundamental alignment to ownership created a the indexing revolution and near destruction of a lot of the traditional high margin brokerage and advisor services on Wall Street.

Bottom line, I am a customer/owner of my home/auto/umbrella insurance via a mutual insurance company, my only brick and mortar banking institution is a credit union and my primary investment house is Vanguard.

I still have life insurance and credit cards from for-profit institutions that the mutual organizations cannot even come close to matching and I am willing to accept and monitor that they continue to align to my goals.

Now, how to align Vanguard's overall very competitive pricing structure and its admittedly weak customer service with this observation is an interesting question. My off-the-cuff thought is that one of the MAJOR inefficiencies suffered by the lack of a profit-motive is a strong incentive to keep and grow customer relationships that is necessary when competing on more than just price. In other words, when looking at the inefficiencies of Vanguard vs. a Schwab, the messy manual processes and weak customer hand-holding has a real cost to Vanguard. As mentioned above, the means that the potential cost advantage of the profit margin could easily be eaten up from those costs.

With at least 2 serious competitors meeting or beating the ER at the fund/ETF level, that difference in service related costs can and will become more apparent. If Vanguard is a competitively minded organization, this may foster/encourage improvements in customer service. Time will tell, and frankly, I believe it is the #1 challenge on their plate today.

One final note, Vanguard still has a MASSIVE ER/cost advantage on actively managed funds (compared on a fund by fund basis, a bit less on a $ invested basis). There may be a hint here that they still have not wrought all of the costs out of their competitors yet on the fund management side. That is another story though...

retiringwhen
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Re: How do brokerages make $s on cheap index funds?

Post by retiringwhen » Sun May 06, 2018 5:54 pm

Spirit Rider wrote:
Sat May 05, 2018 12:42 pm
I still think that Vanguard has an advantage for taxable accounts, but Fidelity and Schwab are competitive options and may have a slight advantage for IRAs.
What is the basis of this observation? I don't seem to have any additional costs for my IRA's at Vanguard, what lower costs does Fidelity or Schwab have over Vanguard for IRAs?

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Re: How do brokerages make $s on cheap index funds?

Post by drk » Sun May 06, 2018 5:59 pm

retiringwhen wrote:
Sun May 06, 2018 5:54 pm
Spirit Rider wrote:
Sat May 05, 2018 12:42 pm
I still think that Vanguard has an advantage for taxable accounts, but Fidelity and Schwab are competitive options and may have a slight advantage for IRAs.
What is the basis of this observation? I don't seem to have any additional costs for my IRA's at Vanguard, what lower costs does Fidelity or Schwab have over Vanguard for IRAs?
Vanguard's advantage for taxable accounts is the tax-efficiency of its mutual funds. In tax-advantaged accounts, Schwab and Fidelity's lower expense ratios can shine depending on other circumstances (i.e. securities lending revenue).

SlowMovingInvestor
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Re: How do brokerages make $s on cheap index funds?

Post by SlowMovingInvestor » Sun May 06, 2018 6:21 pm

Nate79 wrote:
Sun May 06, 2018 5:34 pm
SlowMovingInvestor wrote:
Sun May 06, 2018 3:39 pm
One thing worth pointing out is that Vanguard's money market funds have the highest yields (and lowest expense ratios) by around 30 basis points for individual class funds. Fidelity, Schwab etc. are worse, and TDAM is much, much worse.

Why would other companies be able/willing to beat Vanguard on it's headline index funds expense ratios, but not on money market funds if they could make a profit doing so ? Why is their supposed greater efficiency not applicable to MM funds ?

I suspect that they are subsidizing some of their cheapest funds internally, and really -- internal accounting and cost sharing can be easily modified to subsidize these funds.
Maybe Vanguard's MM funds are loss leaders just like what you are claiming is being done by other firms? Why is it that other firms are wolves in sheep clothing and Vanguard only rides in on a white horse?
"Wolf in sheep's clothing" goes well beyond what I said. I'm not suggesting that Fido or Schwab are doing anything remotely unethical.

But to answer your question, low costs are part of Vanguard's DNA in a way they are not for other firms. Fidelity is/was famous for it's active management and that is still a very profitable LOB. Fido had to be dragged kicking and screaming to index funds. And it was VG that led Fidelity, Blackrock and others to drop their index fund/ETF rates below VGs.

As for money markets, I highly doubt VG is subsidizing them. But neither are Schwab and Fido it's interesting to see how their basic cost structures seem to be generally higher for a plain vanilla fund like an MM fund. Why in that case are they able to drop basic cost structure lower for an index fund and still maintain profitability ?

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beyou
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Re: How do brokerages make $s on cheap index funds?

Post by beyou » Sun May 06, 2018 6:29 pm

Very simple.


If you buy a Vanguard etf at some other broker, Vanguard incurs ZERO cost to service you, but still get some fees. And if you use their brokerage to trade them, while they have servicing costs, they make money on you cash balances, and hidden fees on trade execution.

While fund managers may have made more on active funds in the past, you can’t make profits in the past. This addresses the ability to keep some profit over none.

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