A broker, also known as a brokerage, is a company that connects buyers and sellers of investment vehicles like stocks and bonds. A brokerage account is often where an investor keeps assets. Which type of brokerage to choose is a matter of the investor's needs and preferences.
Quick History of Brokerages
Before the middle of the twentieth century, access to stock and bond markets was restricted to the affluent who had enough money to invest and who could afford the services a human broker to place trades and act as an investment advisor.
In the 1970s and 1980s, a range of so-called discount brokerage firms, such as Vanguard and Charles Schwab, sprang up. They were willing to take on a less affluent clientele because their business models sought to accumulate a large number of small clients.
The late 1990s saw the rise of the internet, and online brokerages such as E*TRADE and FOREX.com were founded to seize the opportunity new technology offered. They extended the discount brokerage model by reducing commissions and minimum balances. That's because they had far less overhead in terms of physical space and human brokers placing trades, so they could pass these savings on to the consumer.
The Rise of Self-directed Investing and Online Brokerage
With lower trading costs, the online brokerage account also brought with it the self-directed investor—the investor who conducts investment research on their own and then chooses which stocks and bonds to buy for their portfolio.
Today, there are a wide array of traditional, discount, and online self-directed brokerage platforms available, each with their own pros and cons.
In addition, a new development over the past few years has been the advent of the robo-advisor. These are automated software platforms, often available as mobile apps, that take care of nearly all of your investment decisions at a very low cost.
Arguably the first robo-advisor, Betterment launched in 2010 after the Great Recession. Since then, robo-advising has seen an exponential growth in adoption and a flurry of both startups and existing brokerages adding a robo-advisor arm.
With all of these choices, then, let’s look at which type of brokerage is best suited for what type of investor. (You should also read our complete guide to picking a stock broker.)
Human Brokers and Financial Advisors
Some people prefer to have a human handle their finances. If this is you, then a traditional human advisor may suit you better than a robo-advisor. Human brokers and financial advisors have been around since the beginning of modern stock markets, and they've carved out a space in today’s competitive landscape by catering to the more affluent investor (typically with $100,000 or more to invest) or those who prefer human interaction.
Effective financial advisors not only build and monitor investment portfolios, but they offer financial advice in all areas of their clients’ lives and provide auxiliary services such as insurance, estate planning, accounting services, and lines of credit, either themselves or via a referral network.
Customers of these brokers can expect to pay around 1% a year or more of assets under management to the advisor, or up to $50 per trade for individual transactions. Many advisors claim that these fees are well worth the extra value that they bring, whether it be their ability to pick stocks appropriate for their clients’ portfolios, their access to unique products and offerings, or a comprehensive financial plan.
Many advisors are available by phone or email and quite responsive. They also usually make a point to meet their clients in person when appropriate.
When comparing this set of brokerages, pay attention to independence. Ask if your advisor is compelled to sell a particular product or service (for example the one offered by their particular company), or if they're able to offer you the best products regardless of which fund family it came from.
Also pay attention to fees. If they’re charging more than 1%, ask why and judge for yourself whether the extra cost is worth it. Professional certifications such as the CFP or CFA designation show that your broker has been trained and has passed a series of rigorous exams related to financial markets and planning.
Customers should use FINRA’s BrokerCheck tool to see if their broker has been subject to regulatory complaints or ethics violations.
Online Self-Directed Broker Accounts
Online self-directed platforms include the likes of E*TRADE, TD Ameritrade, and Robinhood, among many others. Today, most financial institutions and even many banks offer their customers a self-directed online brokerage account.
For example, Capital One, Citibank, or Wells Fargo all offer investing platforms. Almost twenty years into the 21st century, most of the discount brokerage space has consolidated into online investing. (Here are our recommendations for the top online stock brokers.)
For the most part, these platforms leave it up to you to figure out which investments are the best, but they typically offer a suite of research and analysis tools, as well as expert recommendations and insights, to help you make informed decisions. You are then on your own to execute the trades to build your portfolio through their website or mobile app.
These platforms charge a per-transaction commission, usually ranging from $4.95 to $9.95 per stock trade, and an extra $.50 to $1.00 per options contract. They let you trade on margin, create options strategies, and invest directly in mutual funds as well as individual stocks, foreign exchange (forex) and exchange-traded funds (ETFs). (See our picks for the top forex brokers.)
Online brokerages are best for the self-directed investor who knows about the markets or knows how to conduct their own research to choose a portfolio best suited for their goals. If you’re only going to make a few trades a year, you may want to pay a little bit more per trade in order to get access to higher quality research and analysis. If you’re a day trader, you’ll probably want to consider a site that hands out free trades to their most active users.
Each online brokerage has its own strengths and weaknesses. Who you are and what you value will steer you to the one that’s best for you. For instance, some people may value the convenience of having all of their financial accounts under the same roof. Others may value interactive charting. Still, others may value access to IPOs.
Robo-advisors automate investing and use technology to manage your portfolio. Since Betterment launched in 2010, there has been a proliferation of both startups and existing financial companies offering this sort of algorithmic trading service.
Unlike the trading algorithms that power the high-frequency trading (HFT) desks at hedge funds and banks, robo-advisors are likely to put your money to work using low-cost, indexed ETFs. In fact, it is the convergence of ultra-low-fee ETFs with low-cost technology solutions available on mobile platforms that make robo-advising possible.
You can now invest with as little as $1 on some platforms for as little as 0.15% per year in fees. Some platforms don't charge an advisory fee at all, but they charge for optional add-on services.
Before robo-advisors, if you had only a few hundred dollars, or even a few thousand dollars to invest, you’d have to go online to a self-directed platform. Now, you can put your $200 or $2,000 to work without having to conduct any investment research, pick any individual stocks, or worry about rebalancing your portfolio.
Algorithm-based robo-advisors aim to place you in an efficient and diversified passive portfolio. Many of these platforms will even tax-optimize your portfolios with tax-loss harvesting, a process by which an investor sells losing positions to offset the capital gains generated by winning positions. The algorithms themselves are a proprietary company secret of robo-advisors.
Robo-advisors are an ideal option for new or young investors who have little to invest. Minimum balances for robo-advisor accounts are quite low, and some will let you start with as little as $1. These platforms are also good for people who are fans of passive investment strategies, since most often you’ll find your robo-advisor develops a portfolio of indexed ETFs on your behalf.
Robo-advisors also shine for those long-term investors who simply are too busy (or unmotivated) to do their own research on which ETF has the best risk/return characteristics combined with their associated fees, costs, and tax implications.
But robo-advisors are certainly not for everyone. If you're an active trader, you may find them boring or unsophisticated. While robos are adapting to this by allowing for more customizability of portfolio choice (for example, most robos will now let you adjust your allocation weights away from their initial recommendation), it defeats the purpose of these products to start speculating on hot stocks or volatile companies within these platforms. Likewise, if you're a sophisticated investor who needs margin, options trading and technical charts, a robo-advisor is probably not for you.
If you choose a robo-advisor, the factors to consider are primarily cost, reputation, and added services. Monitor the cost of extra services: some are free but others add an extra cost.
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