If you’re at the point of taking investing beyond contributions to a 401(k) and you’re ready to build a portfolio, the first thing you should think about is where you want to open a brokerage account. These accounts allow you to buy stocks, bonds, mutual funds, and other types of investments by paying professionals to buy and sell the ones you choose. In last week’s post we talked about bond basics and I mentioned that you can buy bonds directly yourself. But with the exception of treasury bonds, bonds can be tricky to purchase individually and best left to professionals who buy in high quantities. As for stocks, some companies allow you to purchase stock directly from them. But with stock trade commission’s being so low right now, you’re better off opening an account from a broker you trust and having your stocks in one place.
There are two types of brokers: traditional or discount. (I already like the sound of the discount one, don’t you?) All brokerages charge a commission for you to use their services. The difference lies in what services they offer and how much of a commission they charge.
Traditional brokers work like money managers and offer you advice on what types of investments to make, provide tax guidance and assist with retirement planning. As a result, these brokers are much more costly. These brokers usually charge a commission that is a percentage of your portfolio value, and it can typically be 1-2%. Therefore if your portfolio is worth $100,000, you can plan on being charged a commission of $1,000 – $2,000 each year. These fees could quickly eat away at the returns your portfolio is earning and even delay your retirement date. Some of the best known traditional brokerages include Morgan Stanly, Edward Jones, Merrill Lynch and Smith Barney.
Discount brokers rely on you to make your own investment choices and merely complete the purchase for you, but charge much lower commissions. However, many discount brokers offer lots of resources to help educate you to make better investment choices. The fees for a discount broker vary depending on the type of investment you’re purchasing. Stocks are usually between $5-10 per trade, and mutual funds have percentage based fee, which are significantly less than traditional brokers. TD Ameritrade, Trade King, ScottTrade and E Trade are some of the more popular discount brokers online.
Regardless of the type of broker you choose, make sure you understand their fees up front. They should be clearly stated on their website, but if not give them a call and ask. Even discount brokers have a contact number with professionals available to answer your support questions, like verifying a trade was issued, questions about price and fees, etc.
Think you would like a traditional AND discount broker depending on the type of investment? Firms like Merrill Lynch and Charles Schwab offer both types of services, which provides nice flexibility if you need advice about some investments but not all of them and want your investments in one place.