For the total beginner, a brokerage is a company that you can deposit money with, and then through them have access to publicly traded stocks and other asset classes on the stock exchanges. Anytime you hear someone buy or sell stocks, the trades must be placed through a brokerage company, which essentially acts as an intermediary between a buyer and a seller on the public markets. Most of the big brokerage firms are ones you have heard of: Charles Schwab, E-Trade, TD Ameritrade, Fidelity, and so on. All of these different companies will compete for your business on a number of different levels, including cost of commissions, customer service, access to research, and other factors. Because of their expensive marketing budgets, you might start to think that some companies are safer than others, or that one companies’ mutual funds will always beat the 10-year rolling Lipper average (which, by the way, is a pretty useless statistic that can be changed to suit the need of the advertisement). At the most basic level, though, they all offer the exact same service. My feeling is that you generally get the same result anywhere you go, so you might as well go with the one that charges the lowest commissions but still gives you decent service and platform as well.
But before you choose any, we should cover a few definitions:
Commission: This is the cost of executing the trade. Stock exchanges charge any investor a fee to trade with them directly, but since this is essentially inaccessible to a small investor, you have to go through a third party. The brokerage firm will absorb this cost but then charge you a fixed rate or per-share rate if you trade in higher volume.
Research: While not exactly a difficult buzzword to figure out, “research” refers to the reports and stock analysis that a brokerage will make available for you when you’re in the process of researching a stock. Some brokerages will provide standard reports from a number of “providers,” which are companies like Standard & Poors (S&P), Valueline, Reuters, and Argus. Often, some brokerages have their own research team and offer free evaluation as well.
Capital: This is the amount of money you have to invest with. If you have been saving all your life, then you might have a bigger nest egg than most people. Even if you are just starting out in your first or second job and haven’t saved much, the amount is important when choosing a brokerage.
Margin: Trading on margin essentially means borrowing from the brokerage in order to be able to put more money in the market. If you only fund your account with $5,000, they may let you but up to $7,500 of stocks. However, I don’t recommend trading on margin when you first start out, because you must pay interest to the brokerage while you hold the unofficial loan. Additionally, if the value of the stock drops while you hold it, you may find yourself underwater because you must pay pack the brokerage in the amount you borrowed before you get your money back.
Expense ratio: the fees that you pay into the fund each year that you have money invested. These cover management salary, research, prospectus mailings, and other administrative details.
Prospectus: the overview of a fund a brokerage must provide to you prior to investing in anything. For a mutual fund, it generally will lay out:
- The investment strategy of the fund
- The experience and tenure of the managers
- The top 10 (or 50) holdings of the fund
- Past performance of the fund
- Fees and expenses (see expense ratio above)
Do you plan to be a more active trader, or a passive investor?
This question is hugely important in determining what can be the right choice of a brokerage for you. Everyone has a different style of investing, as some people love following the markets and day trading while others have an automated deposit into their IRA that they check up on semiannually. Either way, you want to find the best brokerage for your investing situation. Of course, most nowadays charge nothing to sign up and fund accounts (after all, that IS how they can make money), so you can open more than one if you are feeling venturesome.
If you intend to be a passive investor…
Or, I should say, a part time investor, then setting up an account to buy mutual fund would be a good idea. The things you should look for here are:
- Low to no commissions
- Wide choice of no-load funds (i.e. funds with no upfront or backend fees)
- Solid company with good track record (more on this later)
- Low account minimums
I personally use Vanguard, and they are definitely an industry leader. I have a few different funds with them right now, and the main reason why I like them so much is that they have among the lowest expense ratios of anyone. They do require an account minimums of $3,000 unless it’s an education savings plan (when it’s only $2,000), so that might be restrictive for some people. However, once you buy shares in a fund, all future transactions can be any amount. Additionally, there is no commission when you buy shares of the company, and this is for two reasons: this is factored into the expense ratio of the fund, and mutual funds have the ability to buy and sell stocks throughout the trading day before they have to fulfill your order, allowing them to get the best price.
Other fund companies to look at (I have not used any of these).
- T. Rowe Price
- TD. Ameritrade
If you want to trade more actively…
Then you want a brokerage that supports day trading and has a powerful platform with charting and technical analysis. I decided several months ago to open an account with thinkorswim, which was recently acquired by TD Ameritrade, though to the best of my knowledge, not much has changed following the acquisition. Thinkorswim charges really low commissions ($5 for stocks), but that isn’t the only reason I like them. The bigger reason was that they have an awesome trading platform! If you download their desktop platform (free), you can see an idea of what I mean. The layout is clean and professional, and you can do all sorts of technical analysis as well as watch live CNBC TV, find out earnings announcements, and see a visual depiction of the market sectors performance that day, among other things. In short, there’s a lot there. Support is great too!
A few top brokerages to check out (that I have not used) are:
- E*Trade ($10 commissions)
- TradeKing (also has $5 commissions)
- OptionsHouse (lowest commissions at $3 per trade)
Again, I have not used any of these brokerages, but have heard various reviews from friends about them. Feel free to check them out! If you have any ideas or use a different one, please let me know in the comments.
Not quite ready to put real money in the markets?
I understand that this is a big move for most people. If you aren’t quite ready to put your own money at risk quite yet, I would suggest opening a “paper trading” account with one of the brokerage companies, so that you can see how the process of buying and selling works while using fictional money. You can check on the real time value of your portfolio at any time during the day, just like if it was an actual account. Thinkorswim offers a paper trading account, which I would recommend just because you can get a feel for their software before actually funding account. If you want an online-based account, I have used Investopedia and Yahoo Finance (click on the “My Portfolios” tab).
Do you have a favorite brokerage that you’ve been using for a while?
I’d love to hear what your experience has been. Let me know a) what you’ve been using, and b) what type of strategy (active or passive) you pursue. Leave a note in the comments!