Selecting a brokerage firm is a decision that is dependent upon each investor and his/her goals. Historically, there was only one type, a brick-and-mortar broker, but with the advent of the digital age and advanced technologies, discount, online brokers now abound. More recently, innovation has resulted in the emergence of companies like Robinhood, an application and online platform that allows for trading of stocks and exchange traded funds (ETFs) without paying a commission.
To make a decision on which one is best for you, a basic understanding of what each offers will assist in making a choice.
Traditional brokerage firms are called “full service” for a reason. Investors can trade an array of financial assets, including stocks, bonds, mutual funds, ETFs, currencies, options and more. This type of brokerage house generally provides a full spectrum of services, including personal advice and planning for retirement (IRAs for example) and taxes, amongst other things.
The level of service goes much deeper than just buying and selling stocks. Traditional brokerages usually provide in-depth research and reports on companies for making investment decisions, as well as regular updates on the investor’s portfolio and counsel on potential changes that may be beneficial based upon the individual’s goals, albeit in the short- or long-term, and risk tolerance. In short, traditional brokers deliver an extremely personalized approach.
That attention comes at a price. For starters, many have requirements on initial deposits to even open an account. Trades may be limited to lots, meaning that a person might not be allowed to purchase $200 worth of XYZ company at $10 per share. A minimum lot of 100 shares may be required, for example.
Furthermore, brokerage fees and commissions are generally higher than other broker options. It is not uncommon for a fee of 2% of total assets under management to be charged annually. This is certainly something to consider as it can erode profits.
It is also something worth noting that many traditional brokers deal exclusively with stocks traded on national exchanges (i.e. Nasdaq, NYSE, TSX) and do not trade “over the counter” stocks. If you’re interested in highly speculative companies, be sure to ask about this when performing due diligence on a broker.
Discount brokers, such as E*Trade, Ameritrade, Scottrade, etc., are also exactly as the name implies; they’re less expensive than traditional brokers. Many of these do indeed offer advanced services, but those services always come at an additional cost. For the most part, discount brokers are designed for the cost-conscious, self-directed investor that wants to execute trades digitally without any assistance from others.
Discount brokers typically provide research and educational tools that is readily available to the public, along with some sort of proprietary trading platform meant to differentiate their firm from competition. The big advantage to discount brokers is minimizing trade costs, with commissions generally ranging from $1 to $10 (charged on each side of the trade). Many discount brokers frequently offer specials to lure in new customers, such as several months of free trades or a specified number of free trades, with greater incentives when an account is opened with a larger amount of money.
Although not standardized, most OTC companies are available for trading through discount brokers.
While discount brokers are far and away the most popular choice for everyday, at-home traders, being educated on what the firm offers is again important. Things like Level 2 quotations sometimes aren’t free, margin charges can vary and minimum initial deposits and balances may be required. If you’re confident that you can manage your trading and long-term investments without the help of a professional, a discount broker just may be for you.
In the last few years, online platforms like Robinhood have emerged. These are generally stripped-down versions of discount brokers, with the spectrum of trading options more limited, along with research, charts and information being inferior to other brokers. The research shortcoming is by design, as Robinhood operates under the assumption that self-directed investors will leverage the power of the Internet to find all the information that they need on their own, which keeps Robinhood’s operating costs down.
Robinhood only allows for buying and selling of stocks, ETFs and (more recently) cryptocurrencies. With that said, Robinhood does limit their trading to larger publicly-traded companies, with penny stock trades generally not allowed on its platform.
So, how does Robinhood make money then? Just like other brokers, it earns interest on money sitting un-invested in accounts. They also pass through regulatory fees with a small mark-up. Robinhood also offers live brokers that are there to assist for a fee, including charges for any trades that are phoned-in or those placed through international exchanges.
Ultimately, there is no saying which brokerage style is best. It is a very personal decision. If you’re interested in OTC stocks (penny stocks), we see little value in traditional brokers or the Robinhood platform and would steer the focus to picking a discount brokerage that works best based on individual needs and requirements. We always recommend a diversified portfolio that includes a number of different assets that creates exposure at several levels of risk. Depending on your experience, using a combination of brokers may be most appropriate. To that end, it is imperative to be well informed on all the options before making any decision.
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