What Type of Brokerage Account Is Right for You?
A broker, also known as a brokerage, is a company that connects buyers and sellers of things like stocks and bonds. It is also often where an investor keeps assets.
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. As recently as the mid-2000’s among more than 10,000 registered investment advisory firms (RIAs), the average account balance was $10,853,630 and the median account balance was $541,673. The individual with $2,000 or even $20,000 (in today’s dollars) to invest was often out of luck.
In the 1970s and 1980s, a range of so-called discount brokerage firms sprang up, such as Charles Schwab, who were willing to take on a less affluent clientele. The discount brokerage business model was 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. 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. As Forbes said in October 1997, “It used to be big companies gaining the advantage through their volume production and other economies of scale, but now, small companies can use the web to trim costs shouldered by the giants. With the web, you don't need a store; you don't need as many salespeople. Such cost savings get passed on to the consumer in the form of lower prices, which in turn drive up sales.”
Self-directed Investing and Online Brokerage Accounts
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 a mobile app, that take care of nearly all of your investment decisions at a very low cost.
The first roboadvisor, Betterment, launched in 2008 on the heels of the Great Recession, with little fanfare. The past ten years, however, has seen an exponential growth in adoption and a flurry of both startups and existing brokerages adding a robo arm. Now there are around 100 such roboadvisors around the world, with combined assets under management expected to reach $20 trillion by the end of the decade.
With all of these choices, then, let’s look at which type of brokerage is best suited for what type of investor.
Human Brokers and Financial Advisors
Some people prefer to have a human handle their finances. Human brokers and financial advisors have been around since the beginning of modern stock markets, and have 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 crave the human interaction.
The best financial advisors not only build and monitor investment portfolios, but hand out 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 1.00% a year or more of assets under management to your 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. Most advisors are available by phone or email and quite responsive. They also make a point to meet their clients in person at least once a year. If you value the human touch, the human advisor may provide better service than a roboadvisor.
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 are they able to offer you the best products regardless of which fund family it came from.
Customers should use FINRA’s broker check tool to see if their broker has been subject to regulatory complaints or ethics violations. 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.
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, 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 ETFs. See our picks for the top forex brokers.
Robinhood, available only as a mobile app, is a new entrant to this space and offers free stock trading. This could be seen as a game changer, but Robinhood does not give you the suite of research, education, and analysis features that traditional online brokerages have. Still, growing competition in the space has driven online trading costs down from over $30 per trade in the late 1990s to as little as nothing on a platform like Robinhood.
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, and 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.
Roboadvisors automate investing and use technology to manage your portfolio. Betterment was the first major roboadvisor that launched in 2008. Since then 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, roboadvisors are likely to put your money to work using low-cost, indexed ETFs. In fact, it is the convergence of ultra-low fee exchange traded funds (ETFs) with low-cost technological solutions available on mobile platforms that make “robos” possible.
You can now invest with as little as $1 on some platforms, with every last nickel invested, for as little as 0.15% per year in fees. Before the robos, 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, with robos, you can put your $200 or $2,000 to work without having to conduct any research, pick any individual stocks, or worry about rebalancing your portfolio.
Algo-based advisors place you in an efficient and diversified passive portfolio. Many of these platforms will even tax-optimize your portfolios, for example by 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. However, the open secret is that most of these algos are creating passive indexed strategies using low-cost ETFs and following some sort of mean-variance optimization strategy to keep things balanced as the markets rise and fall over time.
Roboadvisors are therefore probably the best option for younger investors who are just getting started and have little to invest. Minimum balances are quite low, and robos such as WiseBanyan will let you in 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 develops a portfolio of indexed ETFs on your behalf.
Robos 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 robos are certainly not for everyone. If you are an active trader, you may find robos 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.
If you are a sophisticated investor who needs margin, options trading and technical charts, a roboadvisor is probably not for you. Finally, a roboadvisor is not often going to give you personal advice (or reassurance if things appear to be going badly) over the phone. This may be changing, however; Betterment has just added a roster of financial planners to answer your calls, for example.
If you choose a roboadvisor, the things to consider are primarily cost, reputation, and added services. Many robos now charge as little 0.15% per year and have no transaction costs for trades. While this segment is still young, pay attention to brand names that you can trust. Monitor the cost of extra services: some are free but others add an extra cost. For instance, tax-loss harvesting and regular account rebalancing have become a staple free services, but mortgage loans or insurance products or credit card offers may include an extra cost.
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The Bottom Line
Which brokerage to choose is a matter of taste and it is a matter of constraint. You may really want a human advisor, but only have $100 to invest each month – so you’ll end up with a robo or self-directed. At the end of the day, your finances are your own. Whether you choose your own investments or outsource decision making to an algorithm or a human advisor, make the choice that is right for you. If you make a choice and it doesn’t feel right anymore, or if your circumstances change in a meaningful way – you should always feel that you can switch to a new broker or platform without any guilt or regret. After all, it is your money, not theirs.