Chapter 9
In This Chapter
Understanding the different types of brokerage firms
Shopping for a discount broker
Surfing for an online broker
When you invest in certain securities — such as stocks and bonds and exchange-traded funds — and when you wish to hold mutual funds from different companies in a single account, you need brokerage services. Brokers execute your trades to buy or sell stocks, bonds, and other securities and enable you to centralize your holdings of mutual funds and other investments. Your broker can also assist you with other services that may interest you.
In this chapter, I explain the ins and outs of discount brokers and online brokers to help you find the right one for your investment needs.
Prior to 1975, all securities brokerage firms charged the same fee, known as a commission, to trade stocks and bonds. The Securities and Exchange Commission (SEC), the federal government agency responsible for overseeing investment firms and their services, regulated these commissions.
Beginning May 1, 1975 — which is known in the brokerage business as “May Day” — brokerage firms were free to compete with one another on price, like companies in almost all other industries. Most of the firms in existence at that time, such as Prudential, Merrill Lynch, E. F. Hutton, and Smith Barney, largely continued with business as usual, charging relatively high commissions.
However, a new type of brokerage firm, the discount broker, was born. The earlier generations of discount brokerage firms charged substantially lower commissions — typically 50 to 75 percent lower — than the other firms. Today, discount brokers, which include many online brokers, abound and continue to capture the lion’s share of new business. Many do stock trades, regardless of size, for a flat rate of less than $40, and some do them for less than $20 or even $10 per transaction.
In addition to lower commissions, another major benefit of using discount brokers is that they generally work on salary. Working on salary removes a significant conflict of interest that continues to get commission-paid brokers and their firms into trouble. People who sell on commission to make a living aren’t bad people, but given the financial incentives they have, don’t expect to receive holistic, in-your-best-interest investing counsel from them.
Many of the larger discounters with convenient branch offices offer assistance with filling out paperwork and access to independent research reports. From discounters, you also can buy no-load (commission-free) mutual funds that are run by management teams that make investment decisions for you. Such funds can be bought from mutual fund companies as well. (See Chapter 8 for more on these mutual funds.)
High-commission firms used to argue that discount brokerage customers received worse trade prices when they bought and sold. This assertion is a bogus argument because all brokerage firms use a computer-based trading system for smaller retail trades. Trades are processed in seconds. High-commission brokers also say that discounters are only “for people who know exactly what they’re doing and don’t need any help.” This statement is also false, especially given the abundance of financial information and advice available today.
Which discount broker is best for you depends on what your needs and wants are. In addition to fees, consider how important having a local branch office is to you. If you seek to invest in mutual funds, the discount brokerage firms that I list later in this section offer access to good funds (you can access all exchange-traded funds through a broker because ETFs trade like stocks on exchanges). In addition, these firms offer money market funds into which you can deposit money awaiting investment or proceeds from a sale.
Within the discount brokerage business, deep discounters are firms that offer the lowest rates but fewer frills and other services. Generally, deep discounters don’t have local branch offices like big discounters do, and they also don’t offer money market funds with the highest yields.
Absent from my list are the large discounters Fidelity and Schwab. The simple reason they’re missing is that they charge significantly higher transaction fees than the competition does. These firms can get away with premium pricing, despite comparable services, because enough investors prefer to do business with name-brand companies. Although I think that both companies can offer investors a fine base from which to do their investing, I don’t feel that their fees are justified unless you want to do business with a broker that maintains a branch office in your area. If you’re going to invest in individual stocks (as discussed in Chapter 6), Schwab and Fidelity deserve more consideration because they offer a comprehensive array of useful and independent research resources.
To get the lowest trading commissions, you generally must place your trades online. Even if you’ve never visited an online brokerage site, ads for them online, in print publications, and even on national television have surely bombarded you. Visit any website that’s remotely related to investing in stocks, and you’re sure to find ads for various Internet brokers. Anyone familiar with the economics of running a brokerage firm can tell you that technology, when properly applied, reduces a broker’s labor costs. Some brokerages — thanks to technology — can now perform market orders (which means they’ll execute your trade at the best current available price) for a few bucks. Hence the attraction of online trading.
Before you jump at the chance to save a few dollars by trading online, read the following sections for other considerations that should factor in to your choice of an online broker — or your decision to trade online at all.
If trading online attracts you, first examine why. If you’re motivated by how easily you can check account balances, beware. Tracking prices daily (or, worse, minute by minute) and frequently checking your account balances leads to addictive trading. A low fee of $5 or $10 per trade doesn’t really save you any money if you trade a lot and rack up significant total commissions, and you pay more in capital gains taxes when you sell at a profit. Don’t forget that as with trading through a regular brokerage firm, you also lose the spread (difference between the bid and ask prices when you trade stocks and bonds) and incur the explicit commission rates that online brokers charge.
Frankly, trading online is also an unfortunately easy way for people to act impulsively and emotionally when making important investment decisions. If you’re prone to such actions or if you find yourself tracking and trading investments too closely, stay away from this form of trading and use the Internet only to check account information and gather factual information.
Most of the best investment firms also allow you to trade via touch-tone phone. In most cases, touch-tone phone trading is discounted when you compare it to trading through a live broker, although it’s admittedly less glamorous than trading through a website.
Investment websites also push the surging interest in online trading with the pitch that you can beat the market averages and professionals at their own game if you do your own research and trade online. Beating the market and professionals is highly unlikely. You can save some money trading online but perhaps not as much as the hype has you believe. Online trading is good for the convenience and low costs if you’re not obsessive about it.
Also beware below-market rates on money market accounts and many cut-rate brokers. When you buy or sell an investment, you may have cash sitting around in your brokerage account. Not surprisingly, the online brokers pitching their cheap online trading rates in 3-inch-high numbers don’t reveal their money market rates in such large type (if at all). Some don’t pay interest on the first $1,000 or so of your cash balance, and even then, some companies pay half a percent to a full percent less than their best competitors. In the worst cases, some online brokers have paid up to 3 percent less during periods of normal interest rates. Under those terms, you’d earn up to $150 less in interest per year if you averaged a $5,000 cash balance during the year.
Common complaints among customers of online brokers include slow responses to e-mail queries, long wait times to speak with a live person to answer questions or resolve problems, delays in opening accounts and receiving literature, unclear statements, incorrect processing of trading requests, and slow web response during periods of heavy traffic. With a number of firms that I called, I experienced phone waits of up to ten minutes and was transferred several times to retrieve answers to simple questions, such as whether the firm carried a specific family of mutual funds.
Broker |
Phone Number |
Website |
E*Trade |
800-387-2331 | |
Scottrade |
800-619-7283 | |
T. Rowe Price |
800-638-5660 | |
Vanguard |
800-992-8327 | |
TD Ameritrade |
800-934-4448 |