CHICAGO — If you’re one of the millions of Americans who own stocks and bonds, it’s a good bet that you maintain those investments in a brokerage account. Keeping physical possession of stock or bond certificates in this digital age makes about as much sense as stuffing cash under the mattress.
But opening a brokerage account was only your first decision. These days, you must also decide whether to go with a so-called full-service broker or a discount broker, and it’s important to understand the difference.
Discount brokers such as TD Ameritrade, E*TRADE, Charles Schwab and others typically charge between $2 and $20 for individual online trades; full-service brokers such as Merrill Lynch, Morgan Stanley and others charge as much as 10 to 15 times that much. While competition has caused many full-service brokers to reduce commissions lately, on average, you'll still pay $100-$150 for an average trade done through the typical full-service (translation: full-price) broker. And it doesn’t stop there.
Some full-service firms charge an annual “maintenance” fee for the privilege of having an account with them. Figure on another $100 a year or more for that service.
Of course, you can always sign up for an “advisory account” with your full-service firm. That will provide professional management and unlimited free trades, but it will cost you around 1% of your total assets—per year. In short, full-service brokerages provide their services at a high cost.
In fairness, full-service brokers do try to fulfill all the investment needs of their account holders, including making suggestions for which stocks and bonds you should buy, giving you stock quotes whenever you request them, managing your account (if you ask them to do so), and providing investment research materials and limited tax information—the works.
But, do you get 15 times the value by using an “account executive” who works for Merrill Lynch, Citigroup, Morgan Stanley and the like? Not unless you clearly understand the difference.
Most full-service brokers are salesmen, pure and simple. For the most part, their main trade suggestions will involve their own firm’s stock choices or pricey mutual funds. Brokers get paid a nice percentage (commission) for every sale they make. Therein lies the source of their income—no sales, no income. Despite an individual broker’s best intentions, such an arrangement creates an unarguable conflict of interest.
Full-service brokers usually receive a commission on each trade, so their compensation is directly tied to how often their clients’ accounts are traded. Part of every commission you pay to the firm winds up in your broker’s pocket. In other words, your full-service broker may be paid not for how well your investments perform (which is in your best interest) but rather on how much activity takes place in your account (often the opposite of your best interest).
Certainly, there are knowledgeable and dedicated brokers who do a great job for their clients despite the pressures of that arrangement. Unfortunately, many aren’t especially skilled investors, and some lack impressive or even average performance histories.
Armed with a graduate degree in business, one would-be broker felt that he would have no trouble fulfilling his dream. His vision was quickly shattered when he learned that the big firms weren’t terribly interested in impressive business credentials. What they wanted in their new recruits was sales experience. One interviewer actually suggested that he take a job selling copiers for a couple of years and then come back to reapply.
Eventually, he landed a job with one of the big Wall Street brokerage firms. His training began with a three-day crash course to prepare for the “Series 7 Exam,” which tests prospective brokers on the basics of investing along with the rules and regulations of the Securities and Exchange Commission.
He sat for the exam, with three days’ worth of knowledge packed into his head . . . and he passed. The intensive three days of study paid off; he was now ready to share his newfound expertise. He was now a Stockbroker…Registered Representative…Financial Consultant…Account Executive (the title kept changing).
None of this is intended to suggest that it is a mistake to sign up with a full-service broker. For the investor who feels a need for handholding and the psychological comfort that comes from having guidance from someone with more experience, the full-service brokerage is probably the way to go. Still, in my view, Wall Street’s Big Boys are not the best choice for most of us.
The full-service brokerage industry will become more realistic only when it bases its incentives on performance, not trading frequency. Your broker should be working to give you the best consistent long-term, market-beating return possible, and should receive bonuses based on a percentage of your long-term profits.
Discount brokers, on the other hand, provide a more affordable (if less pampered) means for investors to execute their trades. Discount brokers are for do-it-yourself investors willing to make a little effort to learn what’s in their own best interest. Further, many of the services offered by full-service firms, such as research and stock quotes, are available free to anyone on the Internet. To me, paying exorbitant fees to some full-price broker for sub-par returns makes little sense.
But the job of choosing a discount broker presents the same kinds of challenges found in any shopping adventure. As with other significant decisions in your life, you need to arm yourself with as many facts as you can muster before you take the final step. In short, you need to do your homework before you choose or switch brokers.
Information in this article is provided for educational and reference purposes only. It is not intended to provide specific advice or individual recommendations. Consult an accountant or tax adviser for advice regarding your particular situation.