Find the Best Online Brokerage Firms (for Your Investment Strategy)

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‘Wall Street — a New Era’ by Henry Han (Photo Credits are located at the end of this article.)

The “Undisputed Best” Online Brokerage Firms Myth

Welcome to Earl’s step-by-step guide to selecting an online brokerage firm!  In this multi-part tutorial, I’ll demystify the process of choosing among the many online discount brokers available, in a simple and systematic way according to your personal investment strategy and financial situation.  But, let’s be honest: if it were as easy as typing “best online brokerage firms”, or “cheapest online brokers” (or perhaps even “bestest cheapest online discount brokers”) into a search engine bar and clicking on the top result, then you wouldn’t be reading this guide.

Have you ever held a brokerage account before?

On the contrary, I am guessing that you are here because you’re smart enough to realize that there is no “one size fits all” broker solution for every type of investor, no matter what that excitable fellow on the financial channel (with the rolled up sleeves, loosened tie, and ironically well-maintained stage makeup) might argue to the contrary.  In fact, the best discount brokerage for investor A could very well be the worst choice for investor B — just don’t expect anyone with a commission at stake to tell you that!

Sadly, many (so-called) industry pros aren’t going to give you the straight dope, because it simply isn’t profitable for them to do so.  That’s where I come in!  My mission is to provide a free, objective, and easy to follow step-by-step guide for armchair personal investors who may feel intimidated by the endless sea of online discount brokers available — and it certainly doesn’t help that each one invariably proclaims their services to be “the best.”

But don’t feel dismayed.  While there is no all-encompassing “best online brokerage firm” that is superior to all the rest for every type of investor, I promise that their exists a discount brokerage firm that is a perfect match for your unique investment strategy.  Moreover, by the time that you have completed this series, you will have found it!

So, without further ado:

How This Broker Selection Tutorial is Organized

Wall_Street_Sign_NYC
Street sign at an intersection of Wall Street, in New York City (Photo by ‘JSquish’)

I’ve divided this tutorial into five easily navigable sections for your convenience, spread out over several articles.  The sections following this introduction are indicated by Roman numerals (e.g., I, II, III, IV).  Therefore, the entire tutorial takes on the following format:

1st Article (i.e., The one that you are reading.)

Introduction: It’s what you’re reading right now, silly!  The intro to this guide to choosing an online brokerage firm has three parts: The ‘Undisputed BEST Online Brokerage Firm(s)’ Myth (above); How This Broker Selection Tutorial is Organized (here); Clarifying What Online Discount Brokers Are — and Why You Should Care (below).

Section I. Online Brokerage Firms Have Target Demographics: In the first tutorial section after this three-part introduction, we’ll start narrowing the playing field right away!  I’ll show you how to read between the lines of a broker’s siren call advertisements to determine whether or not you fall into a firm’s target demographic — and whether or not you might be better off taking your business elsewhere (rather than deal with the hassle of a brokerage that is ill-suited to your needs)!

2nd Article

Section II. Online Brokerage Fee Schedule Analysis — Made Easy! Here we’ll discuss the many tactics that brokers employ to leech your money from you.  Make no mistake: NOT all fee schedules are created equal, and the amount of money that online discount brokers will charge for the same service varies from firm to firm.  After reading this section, you will be able to identify the best deals in the biz from those sugarcoated lemons.

3rd Article

Section III. Additional Online Brokerage Services — Mutual Funds and ETFs: After you have become acquainted with the various fees that a discount brokerage may charge for different mutual funds and exchange-traded funds (ETFs), it will be time to assess the quality of these particular securities offered by each firm.  Most mutual fund shares are designed to be purchased for the long haul, so you will want to make sure you pick the firm that offers the best funds available.  Additionally, some online discount brokers offer an incentive for purchasing certain “sponsored” mutual funds and ETFs, by waiving the fees attached to their purchase.  In Section III, I’ll discuss these matters in depth.

Articles 4-5 (forthcoming)

(Note: The articles containing Sections IV-V have not yet been published. But read the short synopsis below to get a glimpse of what to expect from these planned installments!)

Section IV. Customer Service, Software Platform, and Research Tools (Not Necessarily in that Order): Depending on what kind of investor you are, these three interrelated criteria will vary in individual importance.  For example, the ability to speak with a professional, friendly and helpful brokerage rep is absolutely essential to some, an important consideration for others, and merely a bonus for the most independent of investors.  In this section, we’ll talk about how to assess the key elements of an online discount brokers’ overall service, as well as how to determine what matters most — and what you can afford to let slide — according to your personal investment plan.

Section V. Ready, Set … Not Just Yet! In this final section, though you may be chomping at the bit to open your online brokerage accounts, I’ll ask you to reign in your enthusiasm for just a little while longer.  Always remember that discount broker firms are courting you — not the other way around!  Your potential suitors have left attractive coupon offers and other little tsotskis of enticement all over cyberspace, in an attempt to woo your affections. (You just have to know where to look for them!)

Clarifying What Online Discount Brokers are — and Why You Should Care

Rockefellers
The Wealthy Elite: John D. Rockefeller (left) and his son John D. Rockefeller, Jr. (right) — undoubtedly in the midst of a heated debate over the utility of top-hat and monocle ensembles.

One of the most time-tested methods for building personal wealth is by investing in stocks and bonds.  The U.S. Market alone has returned an average annual yield of 10% to investors through the course of its two hundred and twenty year (and counting) history, during much of which as the world’s leading economic benchmark.1, 2 Sure, for years the benefits of investing in the businesses of industry was a privilege reserved for the wealthy elite, and an entire sub-culture of (well compensated) financial management professionals evolved to cater to the needs of these upper-echelon clientele.

However, on a day that is still whispered about around Wall Street office water coolers, in hushed and reverent tones by junior associates, all of that changed —

(Cue the dramatic music while I narrate in “movie preview guy” mode)

Ahem!

***

In a world, where brokerage fees are high and Market participation is reserved for the most affluent Americans, a change — IS COMING!

This summer, the Federal Government is kicking ‘assets’ and taking names.

The rates at which brokers may charge commissions are deregulated, and all hell — BREAKS LOOSE.

Get ready for (investing) action, as the “discount brokerage firm” is born!

And edge-of-your-seat excitement, as you experience compounded returns on your original investment principal!

It’s no holds barred … on Wall Street:

“MAY DAY”
(in theaters 1 May 1975)

***

Okay, that was fun!  But let’s move on, shall we? 

In the wake of May Day, the elusive world of securities trading became accessible to (so-called) middle-class Americans.  No longer would the benefits of investing be  confined to well-established fat cats and their fawning advisors, as free market competition drove brokers to reduce rates by as much as fifty to seventy-five percent in order to attract new business.  Now, industrious and savvy working class individuals could get in the game without having to break the bank with steep brokerage fees!

The resultant increase in investor activity throughout the 1970s, ’80s and ’90s — paralleled by the rise in popularity of mutual funds (see: Mutual Fund Investing for Beginners for the lo-down on these sublime securities) — caused a healthy increase in American “middle class” domestic wealth investments that the Market had previously lacked.  However, advancements in technology culminating in the widespread implementation of the Internet in our daily lives made the real game changer possible, as the phenomenon of the online trading craze was spearheaded by the brokerage firm Charles Schwab, in 1996.  Soon thereafter, every self-respecting discount brokerage in the country had a platform for internet securities trading, and the ensuing scramble to entice new clients drove commission costs down more and more.  For example, Schwab charged $60.00 per trade in 1998, $14.00 per trade in 2006 and $8.95 per trade as of this writing.3 (Ain’t the invisible hand of the free market grand?)

But these days, the choice of which online discount brokers to open accounts with is not as simple as finding the firm with the lowest fees.  Personal investors must take into account a plethora of criteria to find the best brokerage for them (i.e., the broker that at once offers a good value, as well as a platform and services that are suitable to their needs).  To complicate matters even further, recommendations from seemingly reliable industry professionals are almost as varied as the number of online discount brokers themselves.  In 2012, investment newsletter Kiplinger’s rated E*TRADE as the number one online brokerage.  At the same time, SmartMoney granted Fidelity the coveted no. 1 slot, and the website Brokerage-Review.com named OptionsHouse as the best online brokerage.4

Now, you may be asking yourself: “If those in the know cannot even come to a consensus among themselves, what hope is there for the rest of us?” But never fear! Your favorite blue-collar bootstrap hefting bourgeoisie is here to teach you how to quickly sift through the sand of the many online brokerage firms available, and find the precious diamond that is the ideal match for you.

But, what’s that you say?

“Earl — enough of the exposition, already! Get on with the steps to this step-by-step tutorial!!”

Yes sir/ma’am!

Fun Facts: “Discount Brokerages” and/or “Online Brokerages” — What’s the Diff??

“You say tomato, and I say tomahto.  Let’s call the whole thing off!”

These days, the words discount brokerage have become synonymous with online brokerage. That isn’t to say that full-service firms like Morgan Stanley don’t have online brokerage services as well, but when I refer to online brokerage firms in this series of articles, I am primarily speaking of the discount (or “deep” discount) varieties.

Online Brokerage Firms Have Target Demographics

Grant_Wood_-_American_Gothic_-_Google_Art_Project
The folks in the iconic painting ‘American Gothic’, bring to mind an image of traditional Mom and Pop investors!

Few, if any, online brokerage firms will outright refuse to take your money.  That’s the problem!  If brokers were more straightforward about the kinds of investors for which their services are best suited, then the investment world would be much less intimidating.  Instead, many brokerage firms hide behind generalized statements of advertisement, trying to entice as many potential clients into opening accounts with them as possible, irrespective of the unique needs that vary from individual to individual.

For example, in the “Target Customer” section of Barron’s 2013 review of popular brokerage firms, TD Ameritrade is quoted as saying that they serve “… the entire spectrum of the investing and trading community, from the Mom and Pop long-term investors to the highly active trader of derivatives.”5 However, the online investment juggernaut fails to mention their exorbitant fee schedule in this rather broad assertion (among the highest around), which slaps derivatives traders with unnecessarily harsh commission charges at every turn.  But then, I suppose “We’ll be happy to empty your pockets regardless of your personal investment plan” doesn’t sound quite as appealing!

To be fair, TD Ameritrade overcharges for virtually every service, and even conservative investors who do business through the broker — like Mom and Pop — are subjected to hefty fees.  Still, active traders who deal in derivatives would find utilizing a broker that specializes in such securities to be more cost-efficient.  For instance, Interactive Brokers is one of a handful of deep discount online brokerage firms designed to cater to the needs of self-sufficient investors who do a heavy bulk in trading each month.  In fact, the firm’s cut-rate commissions are some of the lowest in the business all across the board.

Does this mean that personal investors of every variety should eschew TD Ameritrade and open an account with Interactive Brokers instead?

Not at all!  One caveat of Interactive Brokers’ reduced fee schedule includes a monthly “minimum” fee of $10, which is levied in the event that investors fail to accrue at least that much in commissioned charges in trading per month.  Therefore, it makes sense for an active trader — such as our derivatives daredevil above — to open an account with the firm, as he or she will ultimately pay less in commission charges (despite the monthly minimum charge) due to the larger volume of trades that proponents of such investment vehicles tend to make.

On the other hand, conservative investors like Mom and Pop who buy and hold their securities for years would be faced with at least $120/yr in fees, irrelevant to their investment strategy, were they to hold an account with Interactive Brokers.  Therefore, TD Ameritrade would be a better choice for them, even with the firm’s heightened per trade fee schedule. (Actually, Mom and Pop would be better off finding an online brokerage with lower fees than TD Ameritrade, but we’ll get to that in Section II!)

Consequently, the first step to analyzing whether or not a discount brokerage firm is right for you is to determine what the broker’s target demographic is.  As I have explained, firms are unlikely to come right out and tell you if it would be in your best interest to shop elsewhere, and then kindly guide you into the welcoming arms of a competitor.  The perpetual give and take that defines our profit-driven society stems from a balancing act between the opposing forces of want (for more capital) and need (to provide a quality service and/or product).

You can't take the sky from me
Thrill-seeker Robbie Knievel is the (metaphorical) embodiment of a derivatives investing daredevil!

Companies such as brokerage firms will take your money gladly, even if they aren’t right for you, for as long as you allow them to.  Only when a broker loses enough business to a rival providing better, less expensive services will they decide to improve what they’re offering out of self-interest.  As such, it is up to the smart consumer to do the research necessary to sniff out the very best “bang per buck,” in order to force providers to keep pushing the envelope towards greater cost-efficiency and quality. (Relax — I’ve done all of the research for you in this case!  Just read on!)

The Importance of Brokerage Account Minimum and/or Inactivity Fees

So, how do you determine which demographics online discount brokers are targeting if you can’t trust them to spell it out for you?  It’s simple!  You just have to read between the lines.  Here’s how:

Most online discount brokers require a minimum start-up investment in order to open an account, and the size of that minimum informs potential investors as to the income bracket of the broker’s favored clientele.  Additionally, though virtually all brokerage firms impose higher comparative rates and fees on clients who invest in smaller amounts — which are incrementally reduced as individual account balances rise — some brokers charge much more than the industry average for account holders who maintain a balance less than some arbitrary amount.  For example, at the time of this writing, Wells Fargo Advisors charges a $60 annual “service fee” for regular account holders who maintain a balance under $50,000 ($35 annual for IRA investors).  Similarly, Vanguard once charged clients with account balances under $50,000 a service fee of $20/yr., but in a move geared towards attracting more business, this stellar provider of mutual funds has since waived the fee for clients who enroll in e-delivery (i.e., those who elect to receive their account statements via e-mail).

Does this mean that investors merely need to identify the new account balance requirements and broker fees for various online firms, and then compare these to their available finances, in order to ascertain online discount brokers’ target demographics?  Not quite. The other type of account minimum to look for when vetting a potential broker has already been touched upon in the example above — trading minimums.  Sometimes called “inactivity fees,” trading minimums are imposed by brokerage firms that encourage active trading among their clients.  Investors who fail to meet the minimum number of trades in a period of time specified by the broker are charged a fee.  This fee varies among brokerage firms, but averages to about $100/yr among those brokers that impose it.

By considering the account minimum requirements (i.e., balance and trading) specified by a company’s fee schedule, you may begin to eliminate brokerage firms from consideration based on your income bracket and investment style.  If you are a working class Joe/Jane with limited funds (like yours truly), then it would not be in your best interest to open an account with an online brokerage that penalizes clients with limited equity.  Similarly, if you are a conservative buy and hold investor (Remember Mom and Pop?), then you will want to steer clear of online discount brokers that are geared more towards frequent traders (like our derivatives speculator), as identified by the presence of inactivity fees.

Check out the table below for minimum balance and inactivity fees charged by some popular online brokerages:

Table: New Account Minimums and/or Inactivity Fees for Selected Brokerage Firms

Brokerage Firms
Minimum to Open Account: Regular (Margin if different, IRA if different)
Broker Fees: Balance (Inactivity if different)
Notes
eOption
$0 for Domestic acct. ($2,000 for Domestic acct., $0 for Domestic acct.)
$50/yr. & $15/yr. for IRAs
$50/yr. fee is for regular (domestic) acct. if one or both are true: 1) balance below $10k 2) less than 2 trades/yr.
E*Trade
500 ($2,000, $0)
$25/quarter
same fee unless one of the following are true: 1) two or more trades/quarter 2) $5k min balance 3) IRA or custodial acct. 4) acct. less than 1 yr. old
Fidelity
$2,500
$25/yr. for SIMPLE IRAs
Firstrade
$0 ($2,000, $0)
None
Interactive Brokers
$10,000 ($10,000 + additional $2000 held in reserve, $5,000)
$0 (minimum of $10/mo. for regular acct., or $7.50/quarter for IRAs)
for Indian citizens acct. min is $5,000; for people younger than 27 acct. min is $3,000
Just2Trade
$2,500
$35/yr for IRAs
unless acct. holds 25k min
Merrill Edge
$0 ($2,000, $0)
None
OptionsHouse
1,000 ($2,000, $1,000)
None
optionsXpress
$0 ($2,000, $0)
None
Scottrade
$500 ($2,000, $500)
None
ShareBuilder
$0 ($2,000, $0)
None
Schwab
$1,000 ($2,000, $0)
None
min. opening balance waived if direct deposit of $100/mo. initiated
SogoTrade
$500 ($2,000, $500)
None
TD Ameritrade
$0 ($2,000, $0)
None
TradeKing
$0 ($2,000, $0)
None
Vanguard
$3,000
$20/yr.
unless one or both are true: 1) signed up for e-delivery 2) $50k min. in acct.
Wells Fargo Advisors
$1,000 ($2,000, $1,000)
$60/yr. for regular acct., & $35/yr. for IRAs
unless one or both are true: 1) $50k min. in acct. 2) PMA acct.

Note: While your author has striven to construct this table with the most accurate data available at the time of writing, please keep in mind that fees can and will change over time.  Remember to verify costs with brokerage firms before opening an account.

Summing it Up:

While online discount brokers that are ill-suited to your needs are more than happy to take your money, doing business with such companies only hurts your potential returns.  There are many, many brokerage firms available, and though the sheer number of options may seem overwhelming at first, this tutorial will guide you towards a firm that is right for you.  The first step to intelligently selecting a discount broker is to honestly assess your personal investment plan and financial situation, then remove brokerage firms from contention who cater to a different target demographic, as determined by studying a company’s broker fees, account balance requirements, and trading minimums.

[Next]–> Check out the 2nd Hub in Earl’s step-by-step tutorial for selecting an online brokerage firm, which includes: ‘Section II. Online Brokerage Fee Schedule Analysis — Made Easy!’

Other Personal Finance Tutorials

If you enjoyed reading this, check out some of my related work listed above!  You might also consider following me on Twitter (@EarlNoahBernsby) and Facebook, to receive notification the moment I publish a new article!  Additionally, you can show support by simply by bookmarking this page, and/or by clicking Facebook and Twitter’s ‘Like’ and ‘Tweet’ icons seen at the beginning of this article!
Thanks,
–E.N.B.

Resources

  1. Timeline [Internet]. NYSE Euronext; [cited 2013 Oct 3]. Available from: http://www.nyse.com/about/history/timeline_trading.html
  2. Investing your money basics, lesson 4 [Internet]. New York, NY: CNN Money; 2012 Jul 10 [cited 2013 Oct 4]. Available from: http://money.cnn.com/magazines/moneymag/money101/lesson4/
  3. May day (brokerage deregulation) [Internet]. [Place unknown]: Wikinvest; [cited 2013 Oct 3]. Available from: http://www.wikinvest.com/wiki/May_Day_(Brokerage_Deregulation)
  4. Maranjian, S. How to find the best online broker [Internet]. [Place unknown]: The Motley Fool; 2013 Jun 25, [cited 2013 Oct 3]. Available from: http://www.fool.com/investing/brokerage/2013/06/25/how-to-find-the-best-online-broker.aspx
  5. Barron’s 2013 online broker review [Internet]. [Place unknown]: Barron’s; 2013 Mar 9, [cited 2013 Oct 3]. Available from: http://online.barrons.com/article/SB50001424052748704836204578349354099321848.html

Photo Credits

  1. ‘Wall Street — A New Era.’ Source: Henry Han, CC-BY-3.0, via Wikimedia Commons. 9 Oct 2009. Available from: http://commons.wikimedia.org/wiki/File:Wallstreet_-_A_New_Era.jpg
  2. ‘The wealthy elite.’ Source: American Press Association, PD-Time, via Wikimedia Commons. Circa 1915. Available from: http://commons.wikimedia.org/wiki/File:Rockefellers.png
  3. ‘A street sign in New York City, NY, at an intersection with Wall Street.’ Source: JSquish, CC-BY-3.0, via Wikimedia Commons. 17 Aug 2011. Available from: http://commons.wikimedia.org/wiki/File:Wall_Street_Sign_NYC.jpg
  4. ‘American Gothic — With a Twist!’ Original painting: Grant Wood, PD-Time(1958), via Wikimedia Commons. Circa 1930. Derivative Art: E.N.B. Photo of original painting available from: http://commons.wikimedia.org/wiki/File:Grant_Wood_-_American_Gothic_-_Google_Art_Project.jpg
  5. ‘Robbie Knievel.’ Source: Bo Nash, CC-BY-2.0, via Wikimedia Commons. 2008 Jun 7. Available from: http://commons.wikimedia.org/wiki/File:RobbieKnievelAirbornTexasMotorSpeedway.jpg
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