How Do Custodians Make Money?

Key Points:

• Custodians earn little from trade commissions today; instead, revenue comes from net interest on client cash, margin loans, payment for order flow, and other sources such as proprietary products and services (including advice).

• The separation between advisor and custodian matters, creating checks and balances that protect investors and provide independent oversight of assets.

• As a fee-only firm, Luminvest does not receive compensation from custodians or investment products, and aims to provide clear, transparent insight into how custodians generate revenue.

Custodians play a critical role in the investment industry. They hold and safeguard client assets, protect against bad actors, and handle essential operational tasks such as tax reporting, recordkeeping, performance reporting, and the collection and distribution of dividends. Most investors hold their accounts with large, well‑known custodians such as Schwab, Fidelity, Vanguard, BNY Pershing, or Altruist.

Because competition has driven most stock and ETF trading commissions to $0, custodians generate very little revenue from trade fees today. And while bypassing a custodian and working directly with an advisor might appear simpler, history has shown the risks—Bernie Madoff’s clients learned this the hard way. When working with a Registered Investment Advisor like Luminvest Wealth Management, it’s important that your accounts are held by an independent custodian who provides oversight and grants your advisor limited authority to trade on your behalf. This separation creates an important system of checks and balances.

So if trading revenue has largely disappeared, how do custodians make money?

Net Interest on Cash Balances

One of the largest revenue sources for custodians is the interest they earn on uninvested cash in client accounts. While they pay clients a certain rate on cash, they typically earn a higher rate themselves. The difference—known as the “spread” or “net interest”—is a major profit center. Some custodians automatically sweep cash into a money market fund, though not always the highest‑yielding option.

At Luminvest Wealth Management, because we are independent and compensated solely by fees paid directly by our clients, we aim to keep idle cash low or invest it in higher‑yielding ETFs or money market funds when appropriate.

Payment for Order Flow

Custodians may receive compensation for routing client trades through certain intermediaries. The payment per trade is negligible, but it adds up across millions of transactions. This practice has existed for decades, and custodians are required to conduct “best execution” reviews to ensure trades are executed at competitive prices.

Securities Lending

Custodians can lend out securities held in client accounts to other market participants. Clients retain full ownership and can sell their securities at any time. Many investors earn a small amount of additional income through this program, though the amounts are typically modest.

Margin Lending

When clients borrow against their portfolios, custodians earn interest on those loans. Margin lending is a meaningful revenue stream.

Revenue‑Sharing Agreements with Mutual Funds (12b‑1 Fees)

Although less common in modern portfolios, some mutual funds pay custodians a portion of the fees they collect. These arrangements are more prevalent with older share classes and actively managed funds.

Trading and Other Commissions

While most ETFs and many mutual funds trade with no transaction fee, some mutual funds still carry trade costs—often $25 to $50 per transaction. At Luminvest Wealth Management, we generally avoid these trade fees by selecting ETFs and mutual funds that trade without commissions.

Platform Fees

Some custodians charge financial advisors a platform fee for access to their technology and infrastructure. Fidelity, for example, may charge advisors depending on how profitable the clients are to Fidelity—factors such as cash balances, use of Fidelity products, and trading volume can influence this.

Miscellaneous Fees

Custodians also charge for various administrative services, such as account closing fees, wire transfers, and other operational tasks. These fees are typically transparent and modest—usually under $100 per year for most Luminvest clients.

Conclusion

As a fee‑only firm, Luminvest Wealth Management is compensated solely by the fees our clients pay us—we do not receive any revenue, incentives, or payments from custodians or investment products. Custodians, however, do need to generate revenue to operate their platforms and safeguard client assets, and the items outlined above are the primary ways they do so. Our goal is simply to make these mechanics more transparent so investors understand the true costs of investing and how the industry functions behind the scenes.