Here's the key point to remember: This business model may not ensure that customers get the lowest price. Those firms that buy Robinhood's orders need to make money themselves and thus take a tiny slice off each transaction -- money that would otherwise stay in customers' pockets. That's why those firms are able to justify paying for orders in the first place. Cheap is cheap, but free usually has a cost.
Fidelity Group: My Bloomberg Opinion colleague Nir Kaissar explained how Fidelity Investments “unleashed the power of free.” The big mutual and exchanged-traded fund company recently began offering two no-fee ETFs: one tracks the 3,000 largest U.S. companies by market value, and the other holds the top 90 percent of stocks within various developed international and emerging countries.
As Kaissar pointed out, the company has “more than 1,000 Fidelity mutual funds, including the various share classes, with close to $1.9 trillion in assets and an asset-weighted average expense ratio of 0.46 percent a year.” Those two ETFs may be free, but the rest of the offerings are not, bringing in $9 billion of annual revenue. Fidelity is betting that once it gets zero-fee customers in the door, it will find a ways to sell them something that makes money for the firm.
Charles Schwab: The discount-brokerage firm offers its Schwab Intelligent Portfolios as a robo-adviser for customers at no charge. As with all of the other free lunches, this too comes with strings attached. It uses its own funds, which may not be as cheap as equivalent Vanguard Group or BlackRock Inc. funds. But more controversially (especially to its competitors) it carries a big cash balance of about 9 percent of assets, making money on the spread it collects in interest versus the tiny return it pays to customers. During a bull market, with almost one in 10 dollars not invested in equities, money held in the robo-adviser probably will underperform. But hey, it’s free!
One last point: It isn't just in finance where we see the free-lunch calculus. All it takes is a quick look at the internet. Facebook and similar social-media platforms are free, but not cheap. Facebook, for example, uses what would otherwise be private user information to help advertisers target consumers -- and that's not to mention findings that heavy social-media users have higher rates of life dissatisfaction and that Facebook contributes to compromising some of our most sacred democratic traditions. And let's not even get into Google, which probably knows more about more people's web habits than any company on earth. How do you think it managed to generate $110 billion in revenue last year?
All of this free stuff turns out to be really expensive.
This column was provided by Bloomberg News.