Before the Internet, only the wealthy had access to the investment markets, because of the high cost of brokers who had to execute the trades. All of that has changed, however, because 21st century technology has allowed most stock trading to be executed automatically. Discount brokers provide the portal to this electronic infrastructure at a fraction of the cost of a traditional broker.
But before you open an account, do your research. While discount brokers are the perfect choice for some investors, misconceptions about their business model could prove detrimental to your investment funds.
They Aren’t Fiduciaries
If you have worked with an investment adviser, they may have been bound by fiduciary responsibilities. This means that they have to put your needs ahead of their own and before they make recommendations, they have to know your risk tolerance, goals and other financial information. Ideally, a fiduciary “has your back” much more so than other professionals.
Discount brokers aren’t fiduciaries. If you purchase 500 shares of a highly volatile stock, they probably won’t advise you of the risk that comes with such an investment. When you do your investing through a discount broker, you’re largely on your own.
Education Is General
Discount brokers like Scottrade have user summits as well as branch level educational events. If you’ve always wanted to learn to trade options, they might have an introduction to options class you can attend, free of charge.
What they won’t tell you is that you may not have the knowledge or experience to be an options trader, even after the class. The more trading you do the more money they make, and since options, bonds and other products may come with higher commissions, they’re happy to see you try something new. Those trader workshops are worth attending, but do a lot ofpaper trading before committing real money.
It Might Not Be a Discount
If you switched from a broker-dealer to a discount broker, you’ll probably see a sizable discount if you’re a frequent trader; however, if you have only a small amount of money to invest, those trading commissions can add up fast. Making a trade on $100 worth of stock at a discount broker could easily cost 7% or more, of that $100. To keep trading commissions low, keep your positions diversified but don’t have so many stocks that you’re having to buy and sell frequently, if you have a low account balance.
They Aren’t All the Same
There’s no doubt that there are a lot of discount brokers to choose from and each provides a different level of service. If you’re the type of person who doesn’t need any human contact, the cheapest of the discount brokers may work for you. If you want to be able to stop by a branch office and have a market discussion with a broker, you’ll have to pay a little more per trade.
Some of the full service brokers are now offering stripped down services that allow clients to make trades online, with the help of one of their full service brokers. Don’t assume that all discount brokers are the same.
They Aren’t Just for Small Portfolios
If you’re a person with a higher net worth, the old assumption that discount brokers are for people with a small balance trying to make a quick buck, isn’t true. All trades, regardless of the size, take your money to the same stock market, and although some brokers will tout that they can execute your trade a split second faster than somebody else, that is rarely important to longer-term investors. If you have the knowledge and experience to manage your own money, paying a higher commission per trade with a full service broker may not be necessary.