Economics of Commission-Free Investing Platforms

Commission-free investing platforms generate revenue through various means like platform fees, managed portfolios, interest on uninvested cash, currency conversion fees, and stock lending.

### The Economics of Commission-Free Investing Platforms
* 💰  Commission-free investing platforms generate revenue through various alternative sources, such as **platform fees, managed portfolios, interest on uninvested cash, and currency conversion fees**.
* 📊  Hargreaves Lansdown, a UK platform, earned **£268 million from interest on uninvested cash in 2023**, making it a **significant revenue stream**.
* 📈  Platform fees are another key source of revenue, with Hargreaves charging higher fees for funds compared to shares, which have a **low fixed fee**.
* 🏦  Managed portfolios, like those offered by Hargreaves, can generate **additional revenue for platforms** through **management fees**.
* 💱  Currency conversion fees can be a **significant source of revenue**, with Hargreaves charging **up to 1%** for converting currency to buy foreign-denominated investments.
* 📊  Stock lending is a way for investors to **generate additional revenue** by lending out their stocks, with some platforms allowing investors to **share this revenue**.
* 📈  Contracts for difference (CFDs) and payment for order flow are additional revenue streams for some platforms, although **CFDs are considered risky investments**.
* 🛡️  The Financial Conduct Authority in the UK does not allow payment for order flow, as it creates a **conflict of interest** between the platform and its clients.

Today, we'll dive into an important trend that's shaken up the investment world: commission-free investing platforms. With an increasing number of platforms eliminating both trading commissions and platform fees, many investors are left wondering how these businesses stay afloat. Join me as we unravel the economics behind commission-free investing platforms but also explore what it means for us as investors. This video is sponsored by Incog, an app that helps you take back control of your data privacy. A good place to start is where platforms make their money in the first place, and then we can think about crossing things off the list. The first obvious item is trading commission. If you buy something or sell something, platforms used to charge you an amount of money. Now, this could be a fixed amount, it could be a percentage, but an increasing number of platforms are waiving this commission altogether, and these are the commission-free investment platforms. Another fee which has been waived by many platforms is the platform fee. This can be charged in various ways.

it can be a percentage of the total invested amount, or alternatively, it can just be a fixed monetary amount every year. Now, the more you invest, the more attractive it becomes to fix the fee because then it never goes up. And as a percentage of your invested amount, that falls as you have more money. But again, here, many platforms are choosing to waive that fee. Together, another way the platforms make money is via managed portfolios. These are portfolios created by the platform itself, which means that you have to pay them fees. A somewhat surprising source of revenue for platforms is on the cash that you leave uninvested on the platform. It turns out that now interest rates are higher, this can be a significant source of revenue, as we'll see now. Sometimes you'll buy investments which aren't denominated in your domestic currency. For UK investors, for example, that could be dollar-denominated stocks or dollar-denominated funds. In this case, you may be charged a commission fee by the platform to do the conversion. And on some platforms that

commission can be quite large. And then finally, we'll look at contracts for difference. Not to buy ourselves. These are derivatives which are often leveraged and which often lead to you losing money. But as index investors, these can actually fund a very cheap platform for people who don't trade contracts for difference. Today's video is sponsored by incog, which is an app that lets you take back control of your personal data. You may not be aware of this, but as you live your digital life, you're leaving breadcrumbs of data through sites that you visit. Now, that data can be aggregated and sold legally by companies called Data Brokers. So, the information that these companies can colate would include your name, your address, places you've visited, family members, or things that you've done. And once these different sources of data are cated, it can be used for all sorts of purposes. For example, marketing. And those are just the legal uses. It could also be used by hackers to try and access your personal data. Now, here's my dashboard on incog, and this kind of summarizes what

they've been doing for me. So you can see the removal requests which they've sent out to data brokers and notice how it's gone up over time. That's because they add new data brokers all the time. And they've also got a new feature when you can have up to three email addresses and three physical addresses. Furthermore, they contact the data brokers repeatedly to ensure that they don't surreptitiously get your name back on their databases. So if we switch to the detailed view, I can filter the data brokers according to severity score, for example. So let's focus on data brokers which have a high severity score. You can see that two of them have already been suppressed and full contact is still in progress. The associated risks with this data broker are identity theft, spam email, data leaks, and so on. Now as a viewer of PensionCraft, you can get a discount on your annual Incog subscription of up to 60%. To claim that, use the promo code PENSION. Alternatively, use a link in

the description below, and that also comes with a 30-day money-back guarantee. I thought it would be interesting to look at a platform which isn't commission-free, which charges you for almost every aspect of investing, and that's Harri's Landown. What's interesting here is that it's a very large UK platform. It has almost 2 million customers, but because it's publicly listed, we can look at its income statement, which is broken down by sources of revenue. Now, on the left-hand side of this income statement, you can see the money flooding into Harries Landsdown in 2023. So, this is the revenue generated by its business activities, and it's broken down by category so that we can see which aspect of the business generates how much of the revenue. And the number at the top is a little bit surprising to me in its size. So, you can see that the cash, the uninvested cash on the platform, this is customer cash generated revenue of 268 million. Another large source of revenue was platform fees, and this is for funds.

so for example that would be Vanguard life strategy funds. These are not ETFs. Notice those would be classified as stocks, but that generated an additional 236 million. We finally get to trading Commission in the third category, and that's for trading shares. So that generated 148 million. Now once you buy a share, and that would also include investment trusts and exchange-traded funds, you have to hold them on the platform. So that also generates platform fees for Hargreaves. Hargreaves also has its own managed portfolios, so that generates some additional revenue, although not a lot. That was just £54 million in 2023. And it also has an active savings product where you can effectively make cash deposits with banks, and that generated a fee from the partner banks for Hargreaves Lansdown. Now the revenue there was pretty small. It was just under £9 million. Now I've also shown on the right-hand side of this graph the costs that Hargreaves had to pay to run its business in 2023. Now I'd expect any UK platform to have similar

costs. The biggest cost will be the people that the company employs. Then we've got activity costs, so that would be things like marketing, technology costs because it has to run and maintain a platform, and it also has to pay for data support costs. So, if you call Hargreaves and apparently their support is very good, you have to have someone to speak to. And then finally, it has to pay the Financial Services Compensation Scheme Levy. This is to compensate you if the platform itself goes bust. All platforms in the UK will have to contribute to this fund. Now, notice that Hargreaves is a pretty profitable company, at least in 2023. Quite a lot of profit is left over after it pays all of its costs. So, presumably, you could cross off some of those sources of revenue and still be profitable. And that's what many platforms in the UK have chosen to do in order to attract customers and to scale up their business. So now let's dig into some of those categories starting with trading commission. Well, surprising to me

is how little of the revenue, which is generated by Har Gaves, came from Trading commission. That's despite the fact that those trading costs are pretty high. Now, fund dealing is free on Har Greaves, but if you buy a share, an ETF, an investment trust, or a guilt say, you're going to have to pay a fairly hefty commission. If you don't trade much, the cost of those transactions is just under £122. And yet, the transactional revenue for Har Reaves in 2023 was just over £120 million, a fairly small proportion of its overall revenue of over 700 million. So, in fact, not charging a commission wouldn't be such a great sacrifice after all for Har Gaves or for other platforms. There are other sources of revenue, and so you can see why some UK platforms have made a huge sacrifice in waving this commission altogether. For example, Trading 212 is commission-free, so is Free Trade, and on Vanguard, you don't pay a commission if you don't want to trade on a live price.

but there are alternative sources of revenue. As we'll see, one of those sources of revenue is platform fees. Now, we saw in the case of Hargreaves that platform fees were a substantial source of revenue. And that's partly because of the way it charges its clients. For example, if you have an Isa with Hargreaves, the amount that you pay depends on what you have. If you have funds, it can be quite an expensive platform because there you pay a percentage fee. For the first tier, up to £250k, you pay 45%. And then gradually, the fee on the additional amounts of money falls. However, if you buy shares, and that includes ETFs (remember, exchange-traded funds), the amount that you pay every year is capped at a very low £45 a year. So, effectively, Hargreaves becomes a fixed fee platform, which is actually very competitive. And yet, many of its clients continue to pay for the funds that they hold on the platform, rather than switching their exposure to much cheaper ETFs. If you have a SIPP on Hargreaves.

you can actually see that the cap is higher. It's £200 a year, but still the logic about that fixed fee applies. Now, in order to remain commission-free for your trades, some platforms have decided to go down the platform fee route in order to compensate themselves. So, for example, on Free Trade, there is a free level, but then if you want to have a wider choice of investments but also more features, including tax wrappers like an Isa or a SIPP, you pay more to be on the platform. Other platforms like Trading 212 charge you nothing in order to have an Isa. There is no platform fee, and Vanguard has gone down a kind of combined route where you pay a percentage fee, but that's capped at £375 a year across all of your accounts, whether that's an Isa, SIPP, or general investment account. InvestEngine, which is another UK platform, one of the newer ones, doesn't charge you for its Isa. It doesn't charge you a platform fee at all. And this brings us on to platform-managed portfolios and what invest

engine does charge you for if you choose to use it is their managed port folios. So here they manage the portfolio for you based on your risk appetite, and the way they construct these portfolios is out of cheap exchang traded funds. And in order to provide that service for you, they charge an additional 0.25% for those managed portfolios on top of the fees that you pay for the ETF themselves, which are low fee. So this is one of the ways in which invest engine can avoid you having to pay commission for their DIY product where you you choose whatever ETFs you want. But if you do want someone to manage everything for you and rebalance the portfolio, that option is available for a fairly low fee. Now in addition to all the other sources of revenue that hardgreaves has, it also has its own managed portfolios. There were a suite which it had for a long time, which it still has where the fees are very high. These are in the same Spirit as Vanguard life strategy funds. A risk-graded set of funds but look at

the fees for these they range from 85% to 91%. Those are very high. So, it was interesting to see that Hard Greaves recently came out with a cheaper range of these risk-graded funds. Notice the fees here are just 3%, and that's because it's using passive cheap funds in order to construct these multi-asset funds. Now that interest rates are higher, a very large source of revenue could be interest on uninvested cash, and in the case of Hard Greaves, it is an absolutely huge source of revenue. What's also surprising is the amount of cash which their clients have in their investment accounts. Here you can see a breakdown of their holdings in 2022 and 2023. Notice the cash amounts are around 14 billion, and that constitutes 10% or 11% of the total assets on Hardre platform. So how do you turn that into £269 million of revenue? Well, you do that by skimming off some of the interest which could be paid by money market funds, Har Greaves.

passes through 85% of the money market fund revenue, but it keeps 1.92% for itself. Multiply 14 billion by 1.92%, and that's where you come up with the figure of 269 million. Now, other platforms will pass through more of that cash return to you as an investor. So, if you are going to be leaving a lot of money as cash on the platform, either deliberately or while you wait to invest the money, then it's worthwhile shopping around for a platform which will pass through more of the return. Now, two platforms in the UK really stand out at the moment for passing through more of that interest on cash, and that's Trading 212 and AJ Bell's Dole platform. There, you'll get almost all of the 5%, which is where the current Bank of England base rate is as I make this video. Now, let's look at currency conversion fees, and no surprises here. Yes, Hargreaves Lansdown charges are fairly high rate here. It charges about 1% if you convert your

Sterling to another currency in order to buy a fund or of stock, which isn't Sterling denominated. It's actually a tiered fee that you pay. So that's up to the first 5,000, the 1%. Anything between 5,000 and 10,000 falls to 75% and so on. Now, this is a fee that you can avoid quite easily, simply by not buying foreign denominated investments. Now there is something which people sometimes get wrong, which is they assume that something called the base currency of the fund is the same as its traded currency. What matters to you is the traded currency. For example, the fund I've got in my core portfolio is currently VVG, a Vanguard developed market fund. The base currency there is in US dollar, but I don't really care because that's just an accounting thing. What I care about is the traded currency, which is Sterling. You can always check that because you'll see the market price is quoted in Sterling. That means that when I buy the fund, it's Vanguard that

does the conversion to dollars, or Japanese Yen, or whatever the currency of the investment is. They can do that much more cheaply than I can. So, in a sense, this is a voluntary fee, and you can avoid it by just not buying things which aren't in. But it is certainly a source of revenue for some platforms. We saw that har groups has a fairly high commission as a percentage. Other platforms are much more competitive. For example, on trading 212, the conversion fee is 0.15%. Now, one source of revenue, which some people find worrying, is called stock lending. The idea here is that if you hold stock, you can lend it out to people in return for interest. Think of this as Airbnb for stocks and funds. Now, personally, I'm quite happy to generate extra revenue by doing this. It turns out that you can't do it with an Isa. So, if you have stocks or funds in an Isa, you can't lend them out. But if it's a general investment account, you can. And what some platforms allow you to do is

to share the revenue of that stock lending with them. Why are people borrowing you a stock? You might think, well, it's actually so they can short it. So, stocks which very popular by people shorting the market are the ones which generate the highest revenue for stock lending. That tends to be overpriced stocks or stocks which are just out of favor. Now what you can't do is vote, so you lose the Voting Rights while the stock is Lent out. Most people don't exercise those rights anyway, but you do get the dividend if it's paid to you while it's being lent out. It's actually a synthetic dividend. The person borrowing it will pay you a cash amount which is equivalent to the dividend. So, both you and the platform can benefit from this stock lending, but it's always voluntary. It'll be a setting and you can choose to opt out if you don't want it. Trading 212 offers this, for example, as does Saxo. And in case you are wondering why many Vanguard funds are so cheap, yep.

if you've got an ETF with Vanguard, chances are that they're lending out at least some of the stock in the ETF, and that's one of the reasons why their fees are so low. Another way that platforms make money is via a derivative called a contract for difference. Now, the idea here is that you can trade in a leveraged way and make the difference between the buying and selling price of a stock or a currency. These tend to be very short-term trades. A lot of people lose money with these contracts for difference, and personally, I avoid them completely. However, if you're on a platform which offers CFDs, as they're called, it can actually subsidize your boring low trading frequency activities. Some of the platforms that offer this are Trading 212, also IG, and because the people who trade these products tend to trade a lot, this can offer quite a large revenue for the platforms themselves. The final category is something called payment for order flow, and in the UK, this is not allowed by the regulator. So this diagram is taken from the financial

conduct Authority's paper, and it actually shows you the process by which payment for order flow works. So when you decide to buy or sell something on the platform, your trade is bundled up with all of the other trades from other people, and then it's sold for a commission to a broker. Now, that means that there's an immediate incentive for your platform to find a broker who pays the highest commission, not necessarily the broker who gets you the best buying and selling price. So as the FCA says, these payments create a conflict of interest between the firm, that's the platform, and its clients. This is because they incentivize The Firm to execute its client orders with counterparties based on their willingness to pay commissions. A broker can make a financial gain at the expense of its clients and have an interest in a transaction that is contrary to its client's interests, so that risks inferior execution outcomes, i.e., you don't get the best buy and sell price. Now, in the US, the regulator seems to be absolutely fine with this. So, for example, Robin Hood does this payment for

order flow business all the time, and presumably it's a big source of revenue for the platform, so I hope that's shown you how these platforms, which don't charge a commission fee or a fee for their platform, can make money. There are many ways in which they can do this, and they have to charge something; otherwise, they simply couldn't stay afloat. So really, it's a matter of finding a platform where the fees are aligned with your method of investing in order to achieve the best outcome for you. Now, don't forget our offer from incog. If you use the link in the description below, you'll get 60% off your annual subscription, and you can take back control of your personal data. And as always, thank you for listening.

How Do Commission-Free Platforms Make Money?

My name is Ramin Nakisa and I started PensionCraft in 2016 as I felt strongly that I wanted to teach people how to invest well for themselves so they could stop making costly mistakes and losing their money through having to pay unnecessarily high fees.

Before starting PensionCraft, I worked in investment banking as a strategist and I was a frequent contributor on CNBC and Bloomberg TV. I have written two books about finance and investment: one for professional investors and one that explains how to buy and sell volatility using exchange-traded products.

I publish a new video on YouTube every Saturday and you can join me for a live Q&A on the 1st Thursday of every month at 7pm UK time.

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The Economics of Commission-Free Investing Platforms

Many investing platforms are now eliminating trading commissions and platform fees to attract customers.

These platforms make money through managed portfolios, uninvested cash, currency conversion fees, and contracts for difference.

Incog, a data privacy app, helps users remove their personal data from data brokers, offering a discount to PensionCraft viewers.

The app works to prevent personal data from being used for marketing or by hackers, providing a dashboard to track and remove data from brokers.

Revenue Sources and Costs of Hargreaves Lansdown in 2023

Hargreaves Lansdown, a large UK platform, generated significant revenue in 2023, with 268 million from uninvested customer cash, 236 million from platform fees for funds, and 148 million from trading commissions.

The company's main costs in 2023 were related to employees, activity, technology, and the Financial Services Compensation Scheme Levy, but it still remained highly profitable.

The Impact of Commission-Free Trading on Platform Revenue

Har Gaves generates a small proportion of its revenue from trading commission despite high transaction costs, raising questions about the necessity of these charges.

The platform relies heavily on platform fees, using a tiered fee structure based on the types of investments held, while other UK platforms have opted for commission-free trading and alternative revenue sources.

Some platforms have shifted to platform fees and additional charges for specific features, while others offer commission-free ISAs and cap the annual percentage fee for all accounts, aiming to compensate for the elimination of trading commission.

Hargreaves Lansdown's Revenue Streams and Fees

Hargreaves Lansdown charges an additional 0.

25% for managed portfolios on top of the fees for the ETFs, offering a way to avoid commission for the DIY product.

The company's high-fee risk-graded funds have now been supplemented with a cheaper range, with fees as low as 3%.

Hargreaves makes a significant amount of revenue from the interest on uninvested cash, keeping 1.

92% for itself, which amounts to £269 million.

Foreign Currency Conversion and Stock Lending in Investment Platforms

Investors pay a tiered fee for converting foreign currency when buying non-Sterling denominated investments, which can be avoided by sticking to Sterling investments.

The base currency of a fund is not as important as the traded currency for investors, and some platforms generate revenue by sharing stock lending income with investors.

Stock lending allows investors to benefit from a synthetic dividend and platforms to profit from the practice, with the option for investors to opt out if they choose.

Vanguard and other platforms make money by lending out stock, offering contract for difference (CFD) trading, and through payment for order flow.

CFD trading can subsidize low-frequency trading but carries a high risk of financial loss.

Payment for order flow creates a conflict of interest between the platform and its clients, prioritizing high commissions over the best trading prices.

These platforms utilize these methods to generate revenue and stay afloat without charging traditional fees.