How Does a Brokerage Firm Make Money?

Brokerage firms act as intermediaries, connecting buyers and sellers of financial securities like stocks, bonds, and mutual funds. These firms facilitate transactions and offer various services, generating revenue through a combination of direct client charges and less obvious methods. This article explores how brokerage firms generate income.

Direct Fees and Commissions

Brokerage firms earn revenue through direct fees and commissions. One common method involves per-trade commissions on securities. Historically, brokerages charged a fee for each stock, option, or bond transaction, which could be a flat rate or a percentage of the trade’s value. While this model has evolved significantly with the rise of commission-free trading, some specialized transactions or asset classes may still incur commissions.

Advisory fees are another significant direct revenue stream, particularly for firms offering financial planning and wealth management services. These firms often charge a percentage of the assets they manage for clients, known as Assets Under Management (AUM) fees. AUM fees typically range from 0.5% to 1.75% annually. For example, a client with $500,000 under management at a 1% AUM fee would pay $5,000 per year. Some advisors also charge flat fees for comprehensive financial plans or hourly rates for specific consultations, which might range from $150 to $400 per hour.

Beyond trading and advisory services, brokerages levy various administrative and service fees. These include annual account maintenance fees. Transfer fees, such as those for an Automated Customer Account Transfer Service (ACATS), are common when moving an account to another firm, typically ranging from $50 to $100. Inactivity fees apply to accounts with little or no activity, often ranging from $10 to $50 per month. Additional charges may encompass fees for physical statement delivery, wire transfers, or access to premium research.

Indirect Revenue Generation

Beyond the direct fees charged to clients, brokerage firms employ several less apparent methods to generate substantial revenue. One of the most significant and often debated indirect income sources is Payment for Order Flow (PFOF). This practice involves brokerages receiving compensation from market makers for directing client orders to them for execution. Market makers pay brokerages for this order flow to profit from the bid-ask spread—the difference between their buy and sell prices. While the per-share compensation is often fractions of a penny, these payments accumulate into substantial revenue, especially for commission-free trading platforms. SEC Rule 606 requires broker-dealers to disclose order routing practices and compensation received from market makers, aiming for transparency.

Another substantial indirect revenue stream for brokerages comes from earning interest on clients’ uninvested cash balances. When clients deposit money or receive dividends, this cash often sits uninvested. Brokerages “sweep” these uninvested funds into affiliated bank accounts or low-risk, interest-bearing instruments like money market funds or Treasury bills, earning interest on aggregated balances. While some brokerages may pass a small portion of this interest back to clients, they often retain the majority, which can be a significant profit source, especially during periods of higher interest rates. For instance, one major brokerage firm reported nearly half of its annual revenue in 2023 came from net interest income, primarily from client cash balances.

Securities lending is another method by which brokerages generate indirect income. This involves lending client shares, often from margin or fully paid accounts, to other investors. These borrowed shares are often used by investors for short selling, where they sell borrowed shares with the expectation of buying them back at a lower price. The brokerage earns a fee or interest on these loans. The global securities lending industry generates billions in revenue, highlighting its significance for brokerage firms.

Combining Revenue Streams

Brokerage firms combine direct and indirect revenue streams to form their business models, with emphasis varying by service and clientele. Full-service brokerages, providing extensive financial advice and portfolio management, often rely heavily on Assets Under Management (AUM) fees and commissions for complex or advised trades. Their model prioritizes a higher-touch client relationship, justifying the bundled or percentage-based fees that cover a wide array of services, including research and trading.

In contrast, online discount brokerages and those offering “commission-free” trading have business models that lean heavily on indirect revenue sources. These firms, which empower self-directed investors with technology-driven platforms and low-cost transactions, generate substantial income from Payment for Order Flow (PFOF) and interest earned on uninvested client cash balances. The absence of explicit trading commissions makes PFOF a particularly important component for these firms, allowing them to monetize transaction volume without directly charging clients for each trade. They also benefit significantly from the interest spread on client cash, which can be a considerable source of profit during favorable interest rate environments.

A brokerage firm’s profitability stems from managing its operational scale, trade volume, assets under management, and efficiency. Different brokerage types strategically blend these direct and indirect income methods to serve their distinct customer bases. For example, while full-service firms might generate higher per-client revenue through advisory fees, commission-free platforms achieve profitability through high transaction volumes and the aggregation of indirect income from millions of users.