Robinhood Effect: Why JPMorgan Is Offering Free Stock Trades

How small upstarts are disrupting the financial giants

Sep 05, 2018
Finance

SMITH BRAIN TRUST – In a kind of Robinhood effect, JPMorgan Chase recently launched a new digital investing service with deeply discounted trading fees and free access to the bank’s stock research.

It’s seeking to attract younger, millennial investors and striving to fend off competition from fast-growing startups – notably Robinhood Markets Inc. – that offer unlimited, free app-enabled trading services.

Other major U.S. banks have made similar moves, triggering a mild price war in financial services. But none had dropped fees as sharply as JPMorgan. Its You Trade service will offer users 100 commission-free trades in the first year and charge just $3 a trade thereafter – far less than the $25-per-share rate the bank had been charging. 

Or overcharging, says Albert S. (Pete) Kyle, the Charles E. Smith Chair Professor of Finance at the University of Maryland’s Robert H. Smith School of Business. Kyle wore a yellow jacket on the Chicago Board of Trade in the 1980s before leaving the exchange to teach and research finance in academia. As a research professor, he helped invent a new stock market design that slices away the edge long exploited by high-frequency traders, leveling the playing field between them, retail investors and large institutional players.

He says lower prices from legacy financial institutions in the United States have been long overdue.

“A long, long time ago the securities industry set up a cartel,” says Kyle, taking the historic view of the industry, “with monopolistic pricing of commissions for retail customers.” The commissions were set at high levels, and remained in place for decades, despite the passage of antitrust laws and the evolution of technology that makes buying and selling stocks faster and cheaper than ever before.

He recalls how in the 1970s, the industry began to see added competition on commissions. “Then, technology changed,” he says. “Phone calls became cheaper and electronic communication became cheaper. And the ability to trade, in some sense, became possible to automate.”

Still, commissions have held largely steady. Despite the advent of automation, there was still a substantial amount of human element in trading through the 1980s and 1990s. “It was totally not necessary, but I think it was there to protect the industry so they could extract some transaction costs from customers,” Kyle says.

Today, there are multiple venues where trades can be executed technologically – quickly and largely without human element. “So, a firm like JPMorgan, if they want to start competing, they’ve got technology that they can bring to bear that will make the marginal cost of a trade very low,” he says.

What was lacking was incentive. That is, until firms like Robinhood Markets began to crop up. The California-based startup has gained more than 5 million users and a $5.6 billion valuation since its founding in 2013. 

“The securities industry is ripe for disruption in this country,” says Kyle. “It has historically charged very high fees to customers and given them very poor service.”

Retail clients get little service from the securities industry. The stock recommendations they receive generally aren’t terribly insightful, “and almost can’t be,” Kyle says, since they come from a sales team, rather than from a research division at a well-heeled hedge fund or other asset management firm. “What you might be getting is hand-holding, or emotional support. And you’re paying dearly for that,” he says.

“If you are a middle-class person with a reasonably good income and you want a nice retirement, you need to have a million dollars or more saved before you retire. And if someone is charging you 50 basis points, that doesn’t sound like a lot, but on a million dollars, that’s $5,000 a year. That’s a lot of money,” Kyle says. “Are you getting $5,000 a year worth of handholding? Probably not.”

For a young professional in the United States, there are few barriers to entry for using a service like Robinhood. All that’s needed is the ability and willingness to use a cellphone app. Not much of a barrier for millennials.

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About the Expert(s)

KylePete

Albert S. (Pete) Kyle has been the Charles E. Smith Chair Professor of Finance at the University of Maryland's Robert H. Smith School of Business since 2006. He earned is B.S. degree in mathematics from Davidson College (summa cum laude, 1974), studied philosophy and economics at Oxford University as a Rhodes Scholar from Texas (Merton College, 1974-1976, and Nuffiled College, 1976-1977), and completed his Ph.D. in economics at the University of Chicago in 1981. He has been a professor at Princeton University (1981-1987), the University of California Berkeley (1987-1992), and Duke University (1992-2006).

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