Is SoFi Invest’s brokerage service really free? – Quartz

Social Finance online lender is rolling out a host of new features, from commission-free brokerage to zero fees exchange traded funds and crypto trading. But buying and selling securities, of course, is not free. So how does SoFi plan to make money?

One way startups can offer discounted prices is by spending money on venture capital, like Uber. For brokerage services, there is also the Robinhood model, which makes money from interest on client deposits, charging traders who buy stocks with borrowed money (margin), and selling orders to. ” client actions to market makers who manage transactions (payment for order flow).

San Francisco-based SoFi, which started out in student loan refinancing, says it will lose money on brokerage in the short term. Its stock trading business model is similar to Robinhood’s – it will earn money from interest on accounts receivable, securities lending, and a small amount from payment for order flow. The company has announced that it will publish detailed information on this soon. Over time, if all goes well, she may be able to convince clients attracted to her brokerage services to purchase other higher margin products.

Stock transactions most certainly cost money, as the ongoing cost skirmish between stock exchanges shows, their customers, and regulators (paywall). Money simply possesses come from somewhere. This is important because, at the very least, it is boring to switch brokerage houses if the one you are using is based on an unsustainable business model.

“Commission-free” can also mean that the real cost is hidden elsewhere. Payment for order flow is a good example. Traders known as market makers post quickly updated offers and offers, which is useful for investors because it means that there is a ready market of up-to-date prices available when they want to buy or sell a market. action. Some market makers (in the case of SoFi, a company called Apex decides which market maker receives the order) offer to buy orders from retail investors from the broker and execute trades for them. Other brokers like TD Ameritrade and E * Trade do the same.

Market makers, sometimes referred to as high frequency traders, can save money by executing “over the counter” orders. This means they avoid the fees associated with trading on the New York Stock Exchange or the Nasdaq, for example, by filling a retail stock order directly with their own money. In the United States, market makers are required to provide the best publicly available offer or offer, regardless of how a transaction is executed.

Why would market makers want to buy a bunch of retail businesses? The everyday investor is less informed and trades differently from the pros who, in theory, get in and out of assets more efficiently. Commercial and institutional exchanges can have opposite meanings, which is ideal for market makers who may come up with offers to buy for one and offers to sell for the other. It’s also less risky: When trading on a public exchange, market makers have to compete with other sophisticated traders, as well as big investors who can buy or sell large chunks of stocks, causing ripples. shock on prices. A market maker who buys retail feed takes less risk and should be able to offer better prices as a result.

Imagine that the difference between the offer and the offer is three cents. These three cents are the profit that a market maker expects to earn for completing trades. If the market maker bought SoFi’s retail orders, he could hypothetically give SoFi a penny and keep two pennies to himself. SoFi can pass this money on to customers or keep it as income for itself. If SoFi keeps the money, it is essentially the cost of the brokerage.

“Brokers have to make a choice: discounts for themselves or better prices for their clients,” said Justin Schack, managing director of Rosenblatt Securities, a New York-based institutional brokerage. “What is in the best interest of the customer is obvious.”

Trading is much more complex than this simplified example, but you get the idea. Companies like SoFi and Robinhood that offer commission-free transactions can offer customers a good deal. Likewise, there is nothing wrong with SoFi, Robinhood, or Apex making money by handling transactions.

The point is, “free” doesn’t quite explain what is going on. These Order Flow Payments, Says Former SEC President Mary Jo White in 2014, “Can create conflicts of interest and raise serious questions as to whether these conflicts can be managed effectively.”

Conflict arises when brokers don’t give clients the best possible deal for their trades, but instead go to the market maker who offers them the highest payout. Brokers are legally bound to offer clients the best price, but White was not so sure they were doing so. Others have similar concerns: Class action lawsuit against TD Ameritrade alleges brokerage prioritize its benefits (paywall) on the best interests of retail traders. The online broker disputed the claim.

In this back-and-forth behind the scenes, it can be difficult for the average investor to understand what their broker is costing, directly or indirectly. In the case of Robinhood, co-CEO Vlad Tenev said the company makes about 2.6 cents for every $ 100 of shares traded. To compare, a trader needs to determine the payout that other brokers are making from market makers, and then see if that payout, and to what extent, is transferred. An analysis by the the Wall Street newspaper (paywall) suggests that Robinhood may be more expensive than its rivals.

SoFi’s new “commission-free” brokerage may prove to be a good deal for investors. But it is certainly not free.

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Heard through headphones

“When you talk to the president of Lloyds, he is extremely confident in our future outside the European Union. And that cannot be said, it is an opinion shared by others in the city. “- Financial Times’ Weekly bank Podcast.

The future of finance elsewhere

• Fidelity Investments is under investigation (paywall) by the United States Department of Labor over obscure fees it charges certain mutual funds, according to the Wall Street Journal. The newspaper says the fees could be a way for Fidelity to make up for lost income due to the “unsustainable economy” of super-cheap funds.
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• US personal loans heat up: JPMorgan Chase to sell online loans to its credit card customers. Affirm, started with PayPal Mafia member Max Levchin, has an agreement to offer its loans to Walmart customers.
• British lender collapsed Wonga haunts former clients from beyond the grave. A parliamentary committee said more than 10,000 borrowers were effectively ignored when they asked for compensation.
• Brex, a Silicon Valley startup that provides credit cards to startups, claims to have never had a fault. It offers a new card with a 60-day interest-free line of credit with limits of $ 1 million or more. What could possibly go wrong?

Previously in Finance Future Friday

February 22: How a three-year-old banking startup pulled off a perfect loan record

February 15: Fintech startup founded by Palantir veterans considers one-click mortgage

February 8: Revolut surfs the record boom in fintech investment

This story was corrected in the 9th paragraph to show that the correct title is Managing Director, not Managing Partner. The fifth paragraph has been updated to clarify Apex’s role in market making.