The E*Trade Business Model – How Does E*Trade Make Money?

Executive Summary:

E-Trade is an online brokerage and bank which has developed a variety of financial products. These include the ability to invest in securities, open savings accounts, or even take out loans.

E-Trade makes money via net interest income, payment for order flow, commissions, as well as fees, and service charges. 

Founded in 1982, E-Trade became one of the world’s first online brokerages while pioneering the FinTech movement. The company went public in 1996. In February 2020, Morgan Stanley acquired E-Trade for $13 billion.

What Is E*TRADE & How Does It Work?

E-Trade is a personal finance platform that allows its users to invest money, save for retirement, open a bank account, and even take out a personal loan.

E-Trade has developed a variety of products to make that happen. These include:

  • Brokerage accounts to trade financial assets such as stocks, ETFs, mutual funds, bonds, and more
  • Retirements account, for instance, a traditional IRA, rollover IRA, Roth IRA, and even IRAs for minors
  • Automated investment management through E-Trade’s team of dedicated financial consultants
  • Checking and savings accounts, offered via E-Trade Bank, requiring no minimum opening deposits or balance
  • Stock plan accounts to allow employees to purchase their company’s shares

… and many more. E-Trade also operates a variety of physical branches as well as a customer service hotline should users have any questions about its products.

On top of that, E-Trade offers an extensive amount of educational material in the form of blog posts and explanatory videos.

Users can access E-Trade products via the company’s website as well as on its mobile and tablet applications (available on Android and iOS devices).

E*TRADE Company History

E-Trade, headquartered in New York City, was founded in 1982 by William A. Porter and Bernard A. Newcomb.

When Porter, who was born in 1928 and died in 2015, was just 16 years of age, he dropped out of high school to join the United States in the fight against Nazi Germany. Fortunately for humankind, he was kicked out immediately after his true age was discovered.

He went on to finish his high school and then pursue a master’s degree in Physics from Kansas State and an MBA from MIT.

After holding various managerial positions at companies like General Motors, Porter started his first company, Commercial Electronics Inc., in 1968. The firm introduced a variety of innovations, such as the first low-light (night vision) broadcast television camera – a technology used to this date.

In fact, Porter has 14 patents registered to his name, many of which were widely adopted by both private corporations as well s the military.

Unfortunately, the 1970s were a little less kind to him. The 1973 – 1975 recession (caused by a meteoric rise in oil prices) forced his customers (TV stations, for the most part) to cancel all of their orders. To make matter worse, his wife told him that she wanted a divorce, requiring him to take care of their children.

At the time, more than 280 people were employed by Commercial Electronics – and none of them were getting paid. As a result, Porter was forced to sell the company to Warner Communications.

After selling his company, Porter wanted to invest a portion of that money into stocks. Unfortunately, he was not able to find real-time stock quotes. He figured that he wouldn’t be the only person having said problem.

The moment he realized that his problem was commercially viable was when he bought an Apple II and saw first-hand how personal computers could affect households around the world. After meeting Newcomb, who is legally blind, at a Palo Alto party in 1980, the pair decided to solve this transparency problem themselves.

With $15,000 of their own money, they set out to create a software program that could access real-time market information and conduct trades during market hours. The company was launched as Trade Plus in 1982.

In the beginning, it primarily contracted with other financial service companies, allowing their employees to improve their trade execution. Institutional customers then paid a variety of service and subscription fees to use the software.

Trade Plus continued to expand its client base throughout the 1980s, adding hundreds of customers to the mix. Yet, it continued to face setbacks, in particular during the market crash of 1987. The crash, known as Black Monday, wiped out a substantial number of the firm’s clients.

Porter, unfazed by the downturn, continued to build his company. Trading activities started to pick up again in the early 1990s. Furthermore, personal computers simply became more advanced, offering an array of new functionality.

In 1991, Porter took out a few hundred thousand dollars from Trade Plus and used it to launch a new company called E*Trade Securities. The software was a heavily discounted version of Trade Plus, allowing retail investors to place trades at a fraction of the cost.

With more and more households being connected to the internet, E-Trade was off to the races. Interest in investing, after the previous economic downturn, was also reaching new heights.

By 1994, E-Trade was generating more than $11 million in annual revenue – making it the fastest-growing company in the United States. That same year, Trade Plus was renamed to E*Trade Group, reflecting the growing importance of its B2C business, which had outpaced revenues of Trade Plus by a landslide.

E-Trade became one of the many companies that eventually went public during the Dot-Com era. In 1996, Porter stepped aside as CEO and handed the key to Christos Cotsakos, a seasoned executive who held managerial roles at Federal Express and served as the CEO of Nielsen. E-Trade IPO’d soon after in April 1996.

During the latter half of the 1990s, E-Trade remained to be a rocket ship of a company. In 1998, the company introduced its first website, thus removing the need to download specific software. By that time, more than 500,000 people signed up for an account.

However, that rocket ship soon came crashing back down to earth. The burst of the Dot Com bubble led to another economic recession – and with that a downturn in trading activity. E-Trade’s stock plummeted from its previous all-time of $63 down to $8.

To make things worse, Cotsakos and the company got under the fire when E-Trade disclosed that its CEO earned $77 million in 2001 – a year in which the company lost $241.5 million. Cotsakos returned $21 million of that salary to the firm and renegotiated his contract, eliminating his base salary and basing everything on incentives (such as the stock’s performance).  

Despite the economic downturn, E-Trade remained in expansion mode. In 2002 and beyond, it opened up a variety of physical branches. It, furthermore, moved into banking and at some point, even possessed the third-largest ATM network across the United States.

Cotsakos eventually resigned in January 2003, leaving the steering wheel to Mitch Caplan who possessed decades of experience in the financial industry. Under Caplan’s leadership, E-Trade continued to invest massively.

In 2005 alone, it acquired Harrisdirect from the Bank of Montreal for $700 million and then followed it up by paying $1.6 billion (in cash) to buy Brown & Company from JP Morgan. Business, again, was booming.

Subprime mortgages, in particular, proved to be a valuable avenue for E-Trade. The company both originated mortgages and invested in them. By 2006, E-Trade was generating $3.9 billion in annual revenue, with over 37 percent being attributable to those mortgage investments.

When the market began to collapse a year later (which today is known as the subprime mortgage crisis), it took both E-Trade and the whole market itself down. E-Trade, like many of its banking counterparts, needed billions of government bailout cash to keep the company alive.

That same year, Mitch Caplan was forced to resign. Throughout the coming years, E-Trade churned through five different CEOs who often only lasted for a year. Luckily for the company, its brokerage business kept its profitability, allowing the company to continue running.

The tide eventually turned with the appointment of Paul Idzik as E-Trade’s newest CEO in January 2013. Idzik led various restructuring efforts, for instance by enhancing communication between the different departments. Traditionally, E-Trade’s technology work was conducted out of Silicon Valley while customer service was based in Atlanta and the corporate finance aspects were handled in New York.

Idzik’s various initiatives eventually allowed E-Trade to become debt-free while consistently turning a profit. Under his leadership, E-Trade even became an acquirer again. In July 2016, the company acquired OptionsHouse for $725 million.

A few weeks later, Idzik was replaced as CEO by Karl Roessner who joined the company back in 2009 as general counsel. His task: revive its online trading business which just a decade ago saved the company from going bankrupt.

Startups like Robinhood had pioneered commission-free trading, leaving traditional players like Charles Schwab, TD Ameritrade, or even E-Trade behind. At the time, traditional online brokerages were still charging anywhere between $7 to $10 to buy and sell stocks.

In October 2019, under the leadership of newly appointed CEO Michael Pizzi, E-Trade announced that it would drop commissions on the majority of the assets tradable on its platform. The move followed announcements from Schwab and TD, which introduced commission-free trading the week prior to E-Trade’s announcement.

While company investors did not like the move, it eventually became a necessary evil to remain competitive against the firm’s more innovative counterparts. In fact, one company, in particular, liked the strategic shift.

In February 2020, Morgan Stanley announced that it would acquire E-Trade for a whopping $13 billion. The investment bank, which traditionally catered to a more affluent clientele, wanted to boost its consumer division. Furthermore, it could cross-sell some of its existing services to E-Trade users.

The acquisition, furthermore, also proved to be timed perfectly. Just weeks after the announcement, trading volumes in the United States (and across the world) skyrocketed to new heights. Many people, fueled by stay-at-home orders and government-induced stimulus checks, picked up trading stocks as a pastime.

Reuters, in February 2021, reported that E-Trade added on more accounts than in the third and fourth quarter of 2020. Meanwhile, E-Trade was able to add on over one million accounts in 2020 alone.

Today, over 4,000 people are employed by E-Trade, which operates more than 20 offices across the United States and beyond.

How Does E*TRADE Make Money?

E-Trade makes money via net interest income, payment for order flow, commissions, as well as fees, and service charges.  

Let’s take a closer look at each of these in the section below.

Interest

The bulk of the revenue that E-Trade generates comes from interest (also called net interest income).

There are a few ways with which net interest income is generated. First, whenever a user trades on margin, he or she effectively borrows money from E-Trade.

The interest rate that E-Trade charges is dependent on how much leverage (i.e. the price of the purchased securities versus how much securities they currently own) the user chooses to take on. Normally, interest rates vary between 5 to 9 percent.

Another major revenue source of interest income is cash held in deposit or checking accounts (via E-Trade Bank). E-Trade then makes money by lending out that cash to other institutions, such as banks or hedge funds, with interest.

Alternatively, individuals can also take out a (personal) loan via E-Trade Line of Credit. They then pay interest, normally between 1.5 percent to 4 percent, on the loan.

Net interest income is affected by two factors, namely how much money is being held in customer accounts as well as the net interest margin.

Fees & Service Charges

Apart from investing on their own, E-Trade users can also receive investment advice from dedicated financial consultants. These investment services are offered through E-Trade Capital Management (ETCM).

ETCM provides investment advice to individuals, corporations, charities, retirement accounts, and many more. E-Trade charges a variety of fees depending on the type of account management as well as money invested.

To that extent, users can also invest in over 7,000 mutual funds. A different fee is charged depending on the fund that is chosen.

E-Trade offers investments into no-load, no transaction fee funds, transaction fee funds, or load funds. Users can, furthermore, select to invest automatically (in this case into no-load, no-transaction-fee mutual funds), which incurs fees of $25 per trade.

For retirement accounts, E-Trade charges a variety of fees, which are all equal to $25. These include:

  • Early withdrawal fees – money is taken out before the age of 59.5
  • Excess fees – too much money is deposited into the account and needs to be withdrawn
  • Recharacterization fees – applied when contributions (that were already committed) change

Other fees include foreign exchange fees (when trading via E-Trade FX), index option fees (when betting on or against stock indices like the S&P 500), various account activity fees (such as $25 for returned transfers due to insufficient funds), and many more. A detailed overview of E-Trade’s fee structure can be found here.

Payment For Order Flow

When users buy a financial asset, such as a stock or ETF, on E-Trade, that order gets rerouted to a so-called market maker. That market maker then compensates E-Trade for bringing in deal flow.

These market makers, similar to stock exchanges like the Nasdaq, make money on the bid-ask spread. They try and match buyers who bid on securities with sellers who try and sell these securities (ask).

Market makers only make a fraction of a cent on these transactions. But since trades are algorithmically executed, they can facilitate thousands of them at any given moment in time. A fraction of that profit is then shared with E-Trade.

E-Trade switched its business model away from commissions to payment for order flow back in October 2019. Robinhood pioneered the practice and brought it into the mainstream. Established brokers like Charles Schwab and FinTech startups like M1 Finance have since adapted it as well.

Nevertheless, the practice of paying for order flow has had its fair share of criticism in the past. For instance, critics argue that retail investors don’t always get the best-quoted price.

Second, the process lacks any form of real-time transparency due to the automatic execution of trades. Lastly, due to the sheer number of trades executed, it is believed that the process can also contribute to market volatility.

According to data from Alphacution, payment for order flow allowed the four major US brokerages, namely TD Ameritrade, Robinhood, E*Trade, Charles Schwab, to generate $2.5 billion in additional income. This is an increase of over 200 percent from 2019 where the four companies ‘only’ made $892 million.

Commissions

Despite the fact that E-Trade cut commissions for the majority of tradeable assets, it did not eliminate them altogether.

In fact, the company still charges commission on options contracts where traders pay $0.65 per contract. Active traders, those who trade over 30 times per quarter, get a reduced rate of $0.50 per contract. Customers also pay $1.5 per futures contract and $1 for every bond trade.

Furthermore, E-Trade charges a $25 commission per order on broker-assisted stock trades. Additionally, a $6.95 commission is to be paid on OTC market transactions. Again, the OTC commission decreases to $4.95 for traders executing more than 30 OTC trades per quarter.

As stated in the company’s last quarterly report (E-Trade stopped reporting earnings after it was acquired by Morgan Stanley), commissions on options contracts make up the majority of its commission-related revenue.

Hi folks, my name is Viktor! By day, I lead a tech team of 10 for an e-commerce startup. At night, I work on expressing my weird thoughts through this blog. And if there's time, I cuddle my cat..