How do brokers make money? 10 methods!
Are you curious how stockbrokers earn money? In this article, I will reveal how an online stockbroker makes money.
What is a broker?
A broker is a company that facilitates the trading of stocks and other securities. Are you curious about which brokers I personally like to invest with? Compare my favourite brokers directly:
Method 1: Transaction fees
The most obvious method for a broker to make money is by charging transaction fees. Many brokers charge a fixed commission or a percentage of the value of your stock transaction.
Variable costs
With some brokers, you pay a percentage on your order. For example, you might pay 0.1% on the total amount of your investment.
Fixed costs
Nowadays, more and more brokers charge a fixed amount per investment, for example, $2.
Spread
Some brokers also charge an increased spread: they widen the difference between the buy and sell price. This is a variation of variable costs, read more about the functioning of the spread here.
Method 2: Currency exchange costs
When a European buys American stocks, they need to exchange euros for dollars. Brokers often charge an unfavourable exchange rate for this, which allows them to make a profit.
You can compare the prices of the same stock in euros between broker A and broker B to see the differences between brokers. You can often find information on the surcharge for transactions in foreign currencies in the terms and conditions.
Furthermore, you can avoid these costs by opening an account in the currency in which you trade the most. If you invest a lot in American stocks, you can open a dollar account, and if you invest a lot in British stocks, a pound account may be more suitable.
With some brokers, it is also possible to buy fractional shares. For example, you can own 10% of one share.
However, brokers also know how to make some extra money from this. They do this by keeping a portion of the dividend themselves. For example, if 10 cents is paid out, and you own 1/20th of a share, they can keep a portion of the dividend for themselves. After all, it is not possible to pay out half a cent in dividends.
Method 4: Lending securities
Sometimes, brokers lend out your securities to people who are shorting or investing in an ETF. A broker also receives a (small) commission for lending out securities. Lending out your securities comes with a small risk.
Method 5: to lure you to profitable products
Some brokers offer free stock investing in the hope that you will also be interested in one of their other products. They may offer leveraged products, such as CFDs, on which they make more money. Don’t just switch to another investment product without researching whether another method of investing is right for you.
Method 6: financing for margin trading
Many brokers also offer the option of leveraged investing. The broker lends you some money, which allows you to suddenly buy a lot more shares.
The broker earns extra money here too: they charge interest on the negative balance.
Way 7: Hidden fees
Some brokers also charge hidden fees, on which they earn extra money. For example, they may charge fees for withdrawing money or paying out dividends. You may also have to pay for extra services such as current stock prices or stock analyses. Also, monitor inactivity fees: many brokers charge extra when you haven’t used your account for a while.
Way 8: Other income from the portfolio
In addition, the money you deposit with the broker also generates income. The money is kept in a bank account, and the broker will receive a certain interest rate on the total amount. In addition, dividends are received on stocks from time to time, and depending on the broker’s policy, they will either pay out this dividend or keep it for themselves. Nowadays, most brokers simply pay out the dividend to the customer.
Did you know that brokers are allowed to use a certain percentage of the portfolio to buy and sell securities themselves? Brokers will therefore gladly buy liquid stocks such as Apple and Google; they will eventually sell them anyway. They can then allocate these stocks to customers who occasionally buy a few shares, which makes it possible for them to avoid having to buy them on the market.
Some brokers are also allowed to lend out your shares in a short position. This carries extra risks for you as an investor. Always make sure to check whether the broker can lend your shares to other parties!
Method 9: trading against the investor
Some less trustworthy brokers trade against the user. For example, if a user speculates on a rising Apple stock price with a CFD, the broker may short the stock as the counterparty. This is shady, and there is an immediate conflict of interest. Brokers that trade against the interests of their customers can manipulate prices in their own favour. Personally, I prefer to avoid these types of brokers.
Method 10: service fees
Some brokers charge fees for holding an account. This can be either a fixed fee or a percentage of the total invested amount. Personally, I am not a fan of this type of broker, as you even pay fees when you are not trading.
FAQ about brokers
There are now various free brokers available. These types of brokers still manage to earn money by charging fees for other services or by offering speculative investment products with higher transaction fees.
There is no one perfect broker, as each investor has different wants and needs. In the article on selecting a broker, I have made a list of questions you can ask yourself to help you choose.
Auteur
Over Alex Mostert
When I was 16, I secretly bought my first stock. Since that ‘proud moment’ I have been managing trading.info for over 10 years. It is my goal to educate people about financial freedom. After my studies business administration and psychology, I decided to put all my time in developing this website. Since I love to travel, I work from all over the world. Click here to read more about trading.info! Don’t hesitate to leave a comment under this article.
