1. What's a Brokerage Firm?
In the same way you need a bank to store your money, you need a brokerage firm in order to invest it. Brokerage firms are where you keep stocks, bonds, mutual funds, and retirement accounts.
Picking a brokerage firm is, in many ways, less consequential than picking a bank. Most of us don't interact with our brokerage firm every day - or even every month. Still, there are all sorts of ways that picking the wrong brokerage firm can cost you.
The companies that will help you invest fall into a few different categories (though they've bled together somewhat in the last decade or so).
1.) Traditional brokerage firms (e.g., Merrill Lynch, Smith Barney, etc.): These are the firms that have been around for decades and, in the old days, used to pair you up with a man (always a man) in a suit (always a suit) to help you pick stocks. For this privilege, you'd pay a fat commission every time you moved your money.
In a recent (and unfortunate) development, the old-fashioned brokers are pushing people with smaller accounts to use call centers rather than talking to the more experienced individual stockbrokers in the office. Also, a lot of the old-fashioned brokerage firms have moved to charging a set fee based on the amount of assets you have, as opposed to charging commissions for each transaction.
2.) Discount brokers (e.g., Charles Schwab, Fidelity, E-Trade, etc.): Nowadays, "discount brokers" often compete head-to-head with the traditional brokers. They got their discount moniker because they charged smaller commissions, often because there were no brokers there to give you investment advice.
A lot of traditional and discount brokers run their own mutual funds too. In fact, many of these companies are in lots of different businesses - some are part of bigger banks, they may administer your 401(k) plan at work or your 529 college savings plan as well. But these firms will let you buy and store any stock or mutual fund - and plenty of other investments, too.
Again, the big difference between the first two types of firms is price - it can still be much cheaper to invest with a discounter. The traditional stockbrokers offer more hand-holding and advice, especially if you have a lot of money, but the discounters have added staff that does similar work in recent years, too.
3.) Banks: Many banks, like Citi, have owned brokerages for years (in this case, Smith Barney). Others, like Wachovia, have bought brokerages more recently (in this case, A.G. Edwards). Bank of America stepped into the arena big time by agreeing to acquire Merrill Lynch. Wells Fargo has made similar moves.
To add to the confusion, many brokers, like Schwab and E-Trade, have added excellent banking services. Essentially, everyone wants you to store all of your money with them, whatever you're using it for and however often you're using it.
2. Do You Need A Broker?
To figure out if you need an investment broker (and what kind), start by figuring out what it is you want to do with your investment cash. Then consider what you'll need to make each of these goals easily achievable. Consider the scenarios outlined below.
1.) I'm looking to buy and sell shares of stock frequently, because I enjoy the game and think I can win by doing better than the overall stock market.
2.) I'm not a trader, but I do add money each month to my savings and want to invest it as soon as it lands, which means I do need to trade (or at least buy) a fair bit.
3.) I'm investing money for a relatively short-term goal (e.g., buying a home in five years) and probably not moving it around all that much.
4.) I'm setting up retirement accounts - or rolling them over from previous employers - with the intention of hanging on to them for 30 or 40 years.
3. Advice on Choosing a Brokerage Firm
No matter what your goal is, you should definitely test-drive a brokerage firm before opening an account. Scour its web site, visit its offices nearby, and talk to the phone reps to see how smart they seem. And listen carefully to see how much they push their own mutual funds and other products, even when they may not be right for you.
Think you're all set because your parents' broker offered to help you out? Think again. Brokers who do this sort of thing are often simply trying to keep the parents happy, not because they know much about what it's like to start out as an investor or how to help such a person. Ask the same questions you would of any broker before you make a move like this. (Find the right questions to ask in our Grilling Guide.)
In the end, if you follow our advice about index investing and reallocating once each year, it won't matter much where you keep your money. You won't be trading often enough to run up many commissions, and within a few years you'll make enough money overall to avoid any minimum balance fees. And if you're working with an independent financial planner, you can often keep your money anywhere you want and simply act on the planner's advice once each year.
Many of us here at FiLife are with discount brokers ourselves: Schwab, Fidelity and Vanguard, though our fearless leader ended up at Merrill thanks to a wily cold-caller. We like the combination of robust tools and web sites, which the discounters have, and the fact that there isn't a push broker assigned to our account whose motive we need to constantly question.
When we want advice - and getting advice is a good thing - we go to a financial planner. Again, go here to read more about how to find a good one.
The good thing here is that it's not a total disaster if you pick one brokerage firm and then realize you've made a mistake. Switching is a bit of a pain but probably not as bad as switching banks or even primary credit cards these days.
4. Grilling Guide: Questions to Ask When Picking a Brokerage Firm
How much does it cost to trade stocks?
These days, it should be less than $10. If you're going to be trading a lot, you should be trying to pay even less than that.
How many mutual funds can I trade for free - and what does it cost to buy and sell the other ones?
Many brokerage firms have fund supermarkets of various sorts, with hundreds of mutual funds that customers can trade without paying any commissions. If a firm you're considering has no such list, ask what it will cost to buy and sell mutual funds under various circumstances (buying 10 shares or buying 1,000; does selling have different prices; does it depend on the fund; etc.).
Are there any fees for having too low of a balance?
There may be account maintenance fees for customers with low balances. Sometimes, you can avoid these by doing your banking with the firm too, or agreeing to invest money automatically each month.
Am I not allowed to meet with anyone in person if my balance is too low?
Old-fashioned stockbrokers like Merrill Lynch have been requesting that people who have $100,000 or less in their accounts call 800 numbers for support. The firm would rather its exalted brokers not bother with the riff-raff. Apparently, the firm doesn't care that small accounts often grow into giant ones. If this is the sort of company you'd like to do business with, be our guest. But we wouldn't advise it.
What special privileges are there for having more than a certain amount of money invested with you?
At Merrill, you'd get to talk to a real live human in person! Seriously, though, there's nothing wrong with giving better service and pricing to your best customers. Those with bigger balances may get access to mutual funds with lower fees (at Vanguard) or money-market funds with higher rates (Schwab). You might get free advice once per year, or access to special phone lines.
What sort of research tools do you offer?
At the old-fashioned firms, they still employ dedicated research analysts to make buy and sell calls on specific stocks or mutual funds. The discount brokers, meanwhile, have all sorts of online tools to help you pick stocks and funds on your own. If this is important to you, ask for a complete list of everything available before you open an account.
Where do you put the cash in my portfolio?
If your stocks or funds pay off dividends, or if you sell some shares but don't specifically allocate the proceeds of the sale, your broker will likely sweep your money into some kind of money-market account. How much will that account earn? Often, far less than the best money-market accounts normally pay.
This is an obnoxious way for brokerage firms to soak you, and lots of them do it. Find out if yours is one of them and make sure your idle cash ends up somewhere appropriate, namely one of the highest-yielding money-market accounts.
Can you help me manage my portfolio and, if so, what does the advice cost?
Every firm offers a range of advice and charges you for it in all sorts of ways. Ask for a list of all your options, with prices. In many cases, you may be better off simply using a financial planner - someone with no vested interest in you keeping your money at a particular firm or with a particular mutual-fund family.
For more on the business of giving financial advice, see our financial planning guide.
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