The Shift To Free Trading Provided A Valuable Lesson In Disruption

On April 18, 2013, a new company was created that completely upended the business model of trading commissions on Wall Street. 

For the next five and a half years, Robinhood and a bevy of other free trading apps that soon followed took aim at the retail brokerage industry, reaching valuations and acquiring new clients at a rate that indicated they were to be taken seriously by the Wall Street establishment. 

And taken seriously they were—so much so that every major retail brokerage finally threw in the towel on trading commissions in October. The decision by Charles Schwab Corporation SCHW, TD Ameritrade Holding Corp AMTD, E*Trade Financial ETFC, Fidelity, Interactive Brokers Group, Inc IBKR, and Tradestation to offer free trades for U.S. equity and options trades brought “The Fee Wars”—as it came to be known—to an abrupt end. It even directly led to Charles Schwab’s decision to acquire rival TD Ameritrade for a reported $26 billion. 

Though trading fees had been under pressure for decades, and each of those firms deserves credit for adapting to what is clearly a changing competitive landscape, make no mistake: the final move to industry-wide free trading was Robinhood’s doing. 

All of this was a precursor to today, where increased volatility and the elimination of trading fees has contributed to a record amount of retail trading in brokers like Robinhood and the major retail brokers.  

This story is the typical path of disruption. A startup creates a new way of doing business (or in some cases, an entirely new market) and is so successful that everybody else is forced to adapt. But this can lead to the double-edged sword of disruption; what happens when the establishment (the ones being disrupted) move to disrupt the disruptor?

This trend has a name: reverse innovation. And it’s affecting more than just Robinhood. In fact, this very same pattern of reverse innovation has happened in other areas of finance. 

Over the last decade, companies like Wealthfront, Betterment, and Personal Capital have pioneered an entirely new kind of programmatic investing, bringing about the biggest changes to wealth management since Vanguard introduced the index fund in 1975. 

As recently as 2016, some estimates were projecting that robo-advisor assets under management would reach $1.5 trillion in 2019, $2.2 trillion in 2020, and $4.1 trillion in 2022 thanks in large part to the growth of those companies. Not only have those predictions not come to pass, but a look at the leading robo-advisors by AUM shows that for all of the acclaim heaped upon the companies who created modern robo-advising, it’s the incumbents who have come to dominate the space. 

Of the top five robo-advisors who disclose their AUM, three are from Vanguard, Charles Schwab, and TD Ameritrade, according to data compiled by Investopedia as of September. With $161 billion AUM, Vanguard Personal Advisory Service is by far the largest robo-advisor in the market. This is followed by Schwab Intelligent Portfolios ($41 billion AUM), Wealthfront ($21 billion), TD Ameritrade Essential & Selective Portfolios ($19.9 billion) and Betterment ($18 billion). 

To be clear, nobody is suggesting that any of these champions of fintech are imminently doomed. All of the startups named above have a substantial number of accounts that give them a bit of a moat. In Robinhood’s case, they reported having 6 million active users as of the end of 2018. But the company that has always touted its free commission structure and an easy-to-use app just lost one of its key competitive advantages. So it stands to reason that the nearly $8 billion valuation it received this summer surely lost some of its luster. 

“When it comes to Wall Street and investing, the old guard has a lot of staying power, no matter what innovations come out of fintech,” said Phill Rosen, CEO/Founder of Even Financial, a B2B platform for financial product offers that provides their channel partners the definitive search, comparison, and recommendation engine for financial services. “This is true for all the categories in financial services, and personal loans, credit cards, and retail investing are no different. The new players are upping the ante, but the old guard isn’t going to just roll over and die either.” 

The lesson we can learn from Robinhood and the companies like it is they were so good at disrupting their industry, that maybe they were too good. If they want to survive (and maintain their lofty valuations), they’re going to have to find new ways to once again differentiate themselves from the very companies they were aiming for in the first place.