Choosing an Online Broker – Part I

On 08/12/2010, in Investments, by Jordan Wilson
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For most investors, I believe using an online brokerage firm is the best way to invest.

Online brokers provide the most cost-effective means to invest and the services provided should meet the needs of almost all individuals.

In researching candidates to take your money, you have many choices.

At times, it is difficult to compare options. There are numerous special offers for new clients. There are also preferential pricing and services dependent on your trading activity level, your amount of assets, the trading platform you choose, etc. And many twists to the prices and services are buried in the fine print.

All this serves to (intentionally) make comparisons a challenge.

Today I will look at a few initial considerations when comparing firms. In my examples, I am using current data from each broker’s US website unless otherwise stated.

Broker Reputation

Due to the number of brokers, I suggest immediately reducing candidates to 3 or 4 firms.

Start with independent reviews of online brokers that operate in your country.

Try to focus on as up-to-date surveys as you can find. With the changing technology, bank mergers, corporate takeovers, etc., rankings can change quite quickly over time.

There are many annual surveys performed. You can take a look at a few for 2010, including: Barrons, The Motley Fool, SmartMoney, The Globe and Mail (Canada).

Does the Firm Operate in Your Country?

While many online brokers operate in multiple countries, be aware that firms may not offer their services in every country.

For example, according to its global website, as of August 2010 E*Trade has about 4.3 million clients from more than 40 countries. But if I go to open an account on E*Trade’s global website, I scroll to locate Canada but only find Cambodia, Cameroon, then Cape Verde in the option list. No room for Canadians. There was an E*Trade Canada, but it was sold to and is now known as Scotia iTrade.

Is the Offering Consistent Between Countries?

Some firms do not offer the same service level between countries.

When E*Trade did operate in Canada, E*Trade Canada only offered share trades for companies within North America. However, if you lived in the US, your E*Trade account allowed for trading throughout much of the world.

So when checking reviews make sure that the firms you are interested in operate in your location and allow for the activities in which you wish to engage.

Watch for Minimum Balances and Incentives

Each firm may have a different minimum balance for opening an account.

Usually this is not onerous, but worth knowing in advance.

Both E*Trade and Scottrade require a minimum initial deposit of $500 in cash or securities.

Client Incentives

Firms may provide incentives for clients to open accounts with higher than minimum deposits.

Currently, TD Ameritrade accepts new accounts with a minimum of $500. However, until September 30, 2010, TD Ameritrade is offering incentives to new clients. If you deposit a minimum of $2000, you get 30 days of commission-free internet equity trades. At the regular fee of $9.99 per trade, you can save a little money for the initial month. And if you deposit a minimum of $25,000, you receive 30 days of commission-free trading plus $100.

Alternate Trading Methods (and Pricing)

The whole idea behind online brokers is to trade via your computer.

That should be the main method in which you intend to conduct transactions. Sometimes though, you may want or need alternatives.

Many online brokers also allow trades via registered brokers, human order takers (no investment knowledge), automated telephone systems, and smartphone access. A few firms even have physical locations where you can meet with staff should you so desire.

These may be useful if your situation is such that you cannot always readily access your computer. Being away from home, server crashes, broken computer, connectivity problems are all potential areas that may prevent you from making a crucial trade.

Commissions for online trades will be the lowest of any trading option. The difference in cost between methods can be significant, so try to stick with internet trading. But if you intend to use alternate methods on occasion, make sure you compare available options and costs when assessing various firms.

Commissions

You are charged commissions when you buy or sell an investment.

Commissions are a big reason that investors use online brokers. Internet commissions are extremely low relative to other methods. Most firms offer online trades for under $10.

I believe that a penny saved is a penny that can be reinvested. However, unless you are a day trader, I do not see much difference between a commission of $7.99 and $9.99. So do not blindly choose the firm with the lowest commission to the exclusion of other factors.

Alternate Trading Methods

If you intend to use alternate trading methods, commissions are substantially higher.

Consider the commissions charged for trades on most US listed shares and Exchange Traded Funds (ETFs) by a few US online brokers:

TD Ameritrade: $9.99 Internet; $34.99 Interactive Voice Response (IVR) Telephone System; $44.99 Broker Assisted.

Scottrade: $7 Internet; $17 IVR Telephone Systems; $27 Broker Assisted.

E*Trade: $$9.99 Internet; $54.99 Broker Assisted. I could not determine from their website if E*Trade offers IVR trading.

Notice the sharp increase in cost between trading over the internet or talking to a person.

Further, while the internet trading commissions are relatively equal, there is greater disparity between firms in broker assisted trades.

Discounts

Some online brokers offer discounts on commissions or fees under certain circumstances. These include: active traders who complete a minimum number of trades each period; account balances that exceed specified thresholds; trading platform or product offering used.

E*Trade reduces its Internet pricing to $7.99 if you conduct more than 150 trades per quarter. And, if you trade more than 1,500 times per quarter, you are eligible for further reductions.

In Canada, Scotia iTrade has a 3 tier commission schedule. For US or Canadian equities, the commission is a flat rate CAD 19.99. But if you have assets greater than CAD 50,000, you only pay CAD 9.99 per trade. And of you have assets in excess of CAD 50,000 and trade more than 150 times per quarter, the commission further falls to CAD 6.99.

As with the trading method, always compare prices for the trades you intend to make. This may mean volume per quarter as above, value of the security, or even the asset class.

Not All Commissions are Equal

For trades where commissions are charged, the lowest commissions usually relate to US exchange listed stocks and ETFs valued at greater than $1.

These are the commission rates from our examples above. They are also the ones you see prominently displayed on each firm’s website and advertisements.

Commissions charged on other trades may often be higher than for equity trades.

If you intend to trade securities other than US equities, then you need to compare rates for those asset classes or categories.

You will find differences between companies.

For example, on simple option trading, TD Ameritrade charges their regular equity commission plus an extra $0.75 per contract. Scottrade also charges their regular equity commission but adds $1.25 per option contract.

Fees

Many investors pay close attention to the commission schedule.

Unfortunately, they pay less heed to other fees that may be charged. And these can add up.

Because commissions for online trading are relatively low, brokers need to cover costs and enhance revenues in other ways. It is a safe bet that almost anything you do that creates work for the broker will be charged to you in a fee.

Fees may include being charged for paper account statements, account transfers, wire transfers, tax forms, stock certificate requests, custody holding, and so on.

Look at the fee schedules and determine what you may incur over the next few years. Then compare between brokers.

If you intend to use any banking services offered, I suggest you also compare those fees.

Discounts

The same as commissions, the type of client you are dictates the fees you are charged.

Often you will find that your trading activity and account asset levels will qualify you for discounts or complete exemptions on some fees.

For example, if you average 5 trades per month over a 3 month period or maintain an account balance greater than $100,000, you qualify for the Apex program at TD Ameritrade. In part, this eliminate certain fees that may be charged to other clients.

That is enough for today. We will look at a few more in an upcoming post.

I realize that comparing brokers is not easy. I get frustrated perusing their websites too.

Fortunately, most investors do not require all the bells, whistles, and discount options to create a strong portfolio. That should make finding an online broker an easier process.

10 Responses to “Choosing an Online Broker – Part I”

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  10. Joey says:

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