Assessing the high-commission salespeople’s arguments

One of the many sales tactics of high-commission brokerage firms is to try to disparage discounters by telling you, “You’ll receive poor service from discounters.” My own experience, as well as that of others, suggests that in many cases, discounters actually offer better service.

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 10 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 hard to justify, especially given the abundance of financial information and advice available today.

Selecting a discount broker

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.

Be careful of some deep discounters that offer bargain commissions but stick it to you in other ways, such as by charging high fees for particular services or offering below-market interest rates on money awaiting investment.

Here are my top picks for discount brokers:

• T. Rowe Price (800-225-5132; www.troweprice.com): T. Rowe Price offers a solid family of no-load mutual funds. The company’s brokerage fees are competitive and among those on the lower end for discounters. Its six branch offices are primarily in the Baltimore-Washington metro areas, Florida, and Colorado.
• Vanguard (800-992-8327; www.vanguard.com): Vanguard is best known for its excellent family of no-load mutual funds, but its discount brokerage services have improved over the years. Vanguard has also reduced its brokerage fees in recent years, and its prices are now near the low end of discount brokers.
• TD Ameritrade (800-454-9272; www.tdameritrade.com): This firm was created by the merger of TD Waterhouse with Ameritrade. TD Ameritrade offers competitive commission rates and more than 100 branch offices. The company offers round-the-clock customer assistance.

All the preceding firms offer mutual funds from many fund companies in addition to their family of funds (if they have a family of funds). In other words, you may purchase mutual funds that aren’t in the T. Rowe Price family of funds through the T. Rowe Price brokerage department. Other discounters certainly have good service and competitive rates, so shop around if you desire. Note, however, that you generally pay a transaction fee to buy funds from firms that don’t offer their own family of funds.

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 for many outside mutual fund family transactions. 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, Schwab and Fidelity deserve more consideration because they offer a comprehensive array of useful and independent research resources, and their brokerage fees in that arena are more competitive.

Examining your online trading motives

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. (That’s the big problem with some brokerage trading apps supposedly offering free trading; see Chapter 17.) 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.

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.

Taking other costs into account

Online brokerage customers often shop for low costs. However, by simply talking with many folks who have traded online and by reviewing online forums where customers speak their minds, I’ve discovered that shopping merely for low-cost trading prices often causes investors to overlook other important issues. The biggest problem is firms that nickel-and-dime you with fees. For instance, some brokers whack you $20 here and $50 there for services such as wiring money or simply closing your account. Also beware of “inactivity fees” that some brokers levy on accounts that have infrequent trading. So before you sign up with any broker, make sure you examine its entire fee schedule.

Also beware below-market rates on money market accounts at 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.

Looking at service quality

Common complaints among customers of online brokers include slow responses to email 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.

When you shop for an online broker, check your prospects thoroughly. Here are some things to do:

• Call for literature and to see how long it takes you to reach a live human being. Ask some questions and see how knowledgeable and helpful the representatives are. For nonretirement accounts, if you want to gauge the quality of the firm’s year-end account statements, ask prospective brokerages to send you a sample. If you’re a mutual fund investor, check out the quality of the funds that the company offers. In other words, don’t let the sheer number of funds that the company offers impress you. Also, inquire about the interest rates that the company pays on cash balances. Try sending some questions to the broker’s website and see how accurate and timely the response is.
• Consider checking online forums to see what current and past customers say about the firms you’re considering. Most online brokers that have been around for more than six months lay claim to a number-one rating with some survey or ranking of online brokers. Place little value on such claims.
• Examine what the firm did before it got into the online brokerage business. Would you rather put your money and trust in the hands of an established and respected financial service company that has been around for a number of years or an upstart firm run by a couple of people hoping to strike it rich on the Internet? Transact business only with firms that offer sufficient account insurance (enough to protect your assets) through the Securities Investor Protection Corporation (SIPC). The severe stock market downturns in the early and late 2000s led to major shakeouts, and you need to protect yourself.

Listing the best online brokers

Among the e-brokers I’ve reviewed, my top picks are the following: