Commission-Free Trading
Commission-Free Trading
In 2019, Charles Schwab announced it would eliminate commissions on stocks and ETFs. Fidelity and E*TRADE followed within days. By the end of 2019, every major broker had dropped per-trade fees to zero. The headline was "Free trading for all." The reality is more nuanced: trading is "free" only if you understand what brokers actually earn in exchange, and how that shapes where your order goes and what price you get.
Key takeaways
- Commission-free trading is genuine—brokers earn zero per-trade fees. But they recoup revenue through payment for order flow (PFOF), where they sell your order to a market maker and pocket the spread difference, typically $0.01–$0.05 per share.
- PFOF isn't hidden; it's a measurable economic effect. On 100 shares of a $150 stock, you might lose $0.50–$5.00 to PFOF versus a broker that routes to the public market. Over a lifetime of trading, it compounds.
- For passive index investors who trade rarely (2–4 times per year), PFOF is negligible. For active traders, it's material.
- Brokers earn additional revenue through margin interest (when you borrow), cash sweep programs (where idle cash earns yield and the broker keeps some of it), and premium subscriptions (real-time data, advanced charting).
- Execution quality varies less than it did in the commission era; all major brokers execute at similar prices because PFOF competition drives them to optimize order routing.
The death of the commission era
For most of the 20th century, commissions were fixed and often high. In 1975, the SEC deregulated them, and prices fell. By 2000, online brokers offered trading at $7–$10 per trade. A retiree buying 100 shares of Vanguard Total Stock Market ETF (VTI) would pay $7 to buy and $7 to sell—$14 round trip, or 0.04% of a typical position. For an index investor buying VTI and holding it for 30 years with annual rebalancing, commissions over a lifetime might total $500–$1,000. Not huge, but not nothing.
In 2019, that changed overnight. The incentive to trade less—because each trade cost money—vanished. Brokers feared this would eliminate retail trading and therefore regulatory scrutiny. Instead, order flow revenue (from PFOF) grew dramatically, replacing commissions as the dominant revenue source. In 2023, Fidelity earned an estimated $2 billion in PFOF revenue alone.
Payment for order flow: how it works
When you place an order to buy 100 shares of Apple at a major discount broker, the broker has a choice: route your order to a public exchange (Nasdaq, NYSE) or sell your order to a market maker (Citadel, Virtu Financial, Jump Trading, others).
Public exchange routing: Your order is processed on Nasdaq. Your execution price is the best bid-ask spread visible on the exchange—called the "national best bid and offer," or NBBO. If the NBBO is $150.50–$150.51, you buy at $150.51 (if buying).
Market maker routing: Your order goes directly to a market maker. The market maker has an inventory incentive: they want to profit on the spread between what they pay you and what they sell for. Let's say the NBBO is $150.50–$150.51, but the market maker offers to fill your order at $150.52. You lose $0.01 per share ($1 on 100 shares). The market maker keeps part of that spread and pays the broker to send the order (typically $0.001–$0.005 per share, or $0.10–$0.50 on your 100-share order). That's the broker's PFOF payment.
Multiplied across millions of retail orders daily, PFOF is significant. A study by PIMCO (2021) found that retail investors collectively lose $5 billion per year to adverse pricing versus the NBBO. A later study by the SEC (2023) estimated similar figures.
Who benefits from PFOF?
The market maker benefits by profiting on the spread. The broker benefits by receiving a payment per order. The exchange (Nasdaq, NYSE) benefits by having fewer orders routed to them but still profiting on the orders that are. Who loses? You.
However, the loss is highly variable. If you're buying VTI, a low-volatility, highly liquid ETF, the PFOF routing might cost you $0.005 per share (negligible). If you're buying a thinly traded stock or an exotic option, you might lose 0.50% on the trade to adverse pricing. For index investors, PFOF is a rounding error. For active traders, it's material.
Brokers and PFOF disclosure
Major brokers disclose PFOF to the SEC quarterly in Form 606 filings. These filings show which market makers they use, what percentage of orders go to each, and average execution prices relative to the NBBO.
- Fidelity: Routes significant order flow to major market makers (Citadel, Virtu) but also routes to exchanges. Their Form 606 shows average execution prices within 0.1 basis points of the NBBO for liquid stocks.
- Charles Schwab: Similarly routes to market makers and exchanges. Execution quality is competitive.
- E*TRADE: After being acquired by Morgan Stanley in 2020, E*TRADE's routing changed, but execution quality remains competitive.
- Interactive Brokers: Takes a different approach—charges a small per-share commission ($0.001–$0.002 per share) but doesn't accept PFOF. For very active traders, this can be cheaper than PFOF-based brokers.
If you're curious about a specific broker's PFOF practices, search the SEC's Form 606 database online. The data is public and reveals whether a broker is prioritizing your execution or prioritizing PFOF revenue.
Hidden costs beyond PFOF
PFOF is the most-discussed hidden cost, but it's not the only one:
Bid-ask spreads on mutual funds and ETFs. When you buy a mutual fund, there's no bid-ask spread—it's just the NAV (net asset value). But when you buy an ETF, especially a less-liquid one, the bid-ask spread might be 0.05–0.20%. On a $10,000 purchase, that's $5–$20. This is a market cost (not specific to your broker), but some brokers and market makers are more competitive on ETF spreads than others. Stick to highly liquid ETFs (VTI, VXUS, BND, VOO, VWO, VGIT) and the spread is negligible.
Margin interest rates. If you borrow on margin, the broker charges 5–8% annual interest. This is explicit, but it's easy to overlook. Most index investors shouldn't borrow on margin, so this is minor.
Options execution quality. Options spreads vary wildly between brokers and market makers. If you're trading options, the execution quality matters more than it does for stocks. Some brokers offer superior options execution; others route to worse market makers. If you're learning options, this doesn't matter much; for frequent options traders, it can be material.
Cash sweep programs. When you have idle cash in your account, some brokers sweep it into a money-market fund. The fund earns 4–5% interest (as of 2024), but the broker earns a few basis points for managing the sweep. Fidelity and Schwab now offer 4–5% cash sweep rates, so this is competitive. When comparing brokers, check the cash sweep rate offered.
The economics of commission-free vs. paid
Which is cheaper: a broker with PFOF or a broker charging micro-commissions?
Scenario: You buy 100 shares of VTI at $150. Total position value: $15,000.
Option A: Fidelity (PFOF-based, commission-free). PFOF routing might cost you $0.02 per share: $2 total. Broker's cost to you: $2.
Option B: Interactive Brokers (commission-based, no PFOF). Interactive Brokers charges $0.001 per share ($0.10 minimum, $1 maximum per order). Your order is routed to the exchange, not a market maker. Cost to you: $0.10 (hitting the minimum).
Option C: A broker that charges $4.99 per trade (old-school discount broker, now rare). Cost to you: $4.99.
For most small trades ($10,000 or less), Option A or B is cheaper than Option C. For very large trades (over $100,000), Option B might be cheaper because the per-share commission ($0.001 × 100,000 shares = $100) is less than PFOF ($0.02 × 100,000 = $2,000).
The key insight: for passive index investors at major brokers, PFOF is negligible. You're trading 2–4 times per year in highly liquid ETFs. The total PFOF cost over a lifetime is probably $100–$500. Not worth switching brokers over.
How to minimize execution-related costs
If you care about execution quality, here are practical steps:
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Stick to highly liquid investments. VTI, VXUS, BND, VOO, and similar mega-cap ETFs have spreads under 0.01%. Your execution cost is effectively zero.
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Trade at liquid hours. Place orders during normal market hours (9:30am–4pm Eastern). The spread is tightest then. Placing orders at 3:59pm Eastern or in pre-market (4am–9:30am) exposes you to wider spreads and worse PFOF pricing.
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Use limit orders, not market orders. A market order buys at whatever price is offered; a limit order lets you specify a price. For a $150 stock, you might place a limit order to buy at $150.00 instead of accepting $150.10. You risk not getting filled, but if the stock is liquid (and your buy/sell orders represent a tiny fraction of daily volume), you'll usually fill near your limit.
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Avoid micro-cap stocks. If you're buying a stock with a $50 million market cap and 50,000 shares outstanding, spreads widen and execution quality suffers. Stick to mega-cap stocks and index funds.
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Batch your trades. If you're making multiple purchases, do them in a single order (e.g., "buy $15,000 of VTI, $10,000 of VXUS, $5,000 of BND" in one session). This reduces the number of PFOF events you're subject to.
The regulation question
The SEC has proposed rule changes to require brokers to execute orders on public exchanges rather than selling them to market makers. This "best execution" rule, proposed in 2021, would eliminate PFOF as a revenue source for many brokers. However, as of early 2024, the rule has faced legal challenge and hasn't been finalized.
If the rule passes, brokers will likely shift to other revenue sources: monthly account fees, premium subscription tiers, or higher margin interest rates. The true economic cost of trading might not change—it might just be explicit instead of hidden.
Practical broker comparison on execution
For the typical Pomegra Learn investor, broker choice shouldn't hinge on PFOF. All major brokers (Fidelity, Schwab, E*TRADE, TD Ameritrade) execute similarly well on highly liquid ETFs. The differences matter for options traders or day traders, not for buy-and-hold index investors.
When narrowing your broker choice, focus on account types, fund selection, research tools, and mobile app usability—not on execution quality or PFOF metrics. The latter will vary across maybe $20–$100 per year; the former could cost you thousands if you pick the wrong broker.
Next
Now that you understand how brokers earn money and what commission-free actually means, the next article covers the concrete features you should verify when opening an account: order types, fractional shares, recurring purchases, tax forms, and everything else that shapes whether the platform will support your strategy or frustrate it.