What is a Brokerage Company
A brokerage company’s main duty is to act as a middleman that connects buyers and sellers to facilitate a transaction. Brokerage companies typically receive compensation by means of a commission (either a flat fee or a percentage of the amount of the transaction) once the transaction has successfully completed. For example, when a trade order for a stock is executed, an investor pays a transaction fee for the brokerage company's efforts to complete the trade. The real estate industry also functions using a brokerage company format, as it is customary for real estate brokers to collaborate, with each company representing one party of the transaction to make a sale. In this case, both brokerage companies divide the commission.
In the financial markets, today there are several different types of brokerage firms offering a wide range of products and services, ranging from more expensive full-service brokers where a professional financial adviser manages all investment decisions and provides ongoing advice and support. Discount brokers are often online platforms that allow do-it-yourself (or, self-directed) investors to make their own trading decisions for lower commissions. Recently, there has been a push toward zero trading commissions of ETFs or even all products on several self-directed online platforms. Roboadvisers are a new form of digital financial adviser that offers competent investment management carried out by algorithms with minimal human intervention, and for very low cost. Several roboadvisers offer zero commissions or fees, and you can start with as little as $5 in many cases.
BREAKING DOWN Brokerage Company
Choosing a Company
When choosing a brokerage company to work with, investors have a range of options. An investment brokerage is often authorized to trade securities for buyers and sellers, and so the type of services a person requires depends on their level of market knowledge, sophistication, risk tolerance and comfort in trusting others to manage their money.
Brokerage commissions erode returns over time, so investors should select a company that provides the most economical fees for the services provided. Before opening an investment account, you should do some research and compare fees, products, benefits, customer service, reputation and the quality of services provided. There are several brokerage reviews and comparison tools online, including resources found at Investopedia.
Full-service brokerages, also known as traditional brokerages, offer a range of products and services from money management, estate planning, tax advice and financial consultations. These companies also offer up-to-date stock prices, quotes and research on economic conditions and market analysis. Highly trained and credentialed professional brokers and advisers work at these firms and may form personal relationships with their clients.
Traditional brokerages charge a fee, commission, or both. For regular stock orders, full-service brokers may charge up to $10 to $20 per trade, but many advisers are switching over to a wrap-fee business model where all trades and advice come under one all-inclusive annual fee of typically 1 percent to 2 percent of assets under management (AUM). Many full-service brokers seek out affluent clients and establish minimum account balances required to obtain their services, often starting at six figures or more.
A discount brokerage charges less than a traditional brokerage, but may provide fewer comprehensive services and products and lack that personal relationship found with a full-service adviser; the depth and quality of discount brokers' advice often depends on the size of an investor’s account. Several full-service companies do offer a lower-cost discount brokerage arm as well. These types of companies are able to charge a lower commission by having their clients conduct their own research and trades via computerized trading systems, either web-based or via mobile app.
The first discount brokerage is often attributed to Charles Schwab in the 1970s and 1980s. Since the advent of online trading in the late 1990s, commissions for discount brokers have fallen dramatically, to where they now average around $4 to $5 per trade. Today, most discount brokerages are also online brokerages. A recent trend is for ETF trades executed through online brokers to carry zero commission. Other online brokerages such as Robinhood, which only offer access via a mobile app, are pioneering zero commissions on all trades.
Starting in the 2010s, roboadvisers are a class of digital-only online investment platforms that use algorithms to implement trading strategies on behalf of clients in an automatic manner. Most roboadvisers subscribe to long-term passive index strategies that follow the rules of modern portfolio theory (MPT), although several roboadvisers now allow clients to modify their investment strategy somewhat if they want more active management. The allure of roboadvisers is not only the automation, but also the very low fees and low account balances needed to get started. In many cases, roboadvisers actually charge no annual fee, zero commissions, and you can start with just a few dollars.
Some roboadvisers have now started employing human advisers that clients can talk to, but these advisers often are unable to actually change the recommended portfolio allocation generated by their algorithms. Furthermore, access to an adviser will come with a greater fee, typically 0.25 percent to 0.50 percent of AUM per year - which is still far less than that of a traditional broker.
Independent brokerages are not affiliated with any mutual fund company, but function similarly to a full-service brokerage. Typically, these brokers are not biased and can recommend and sell clients products that are in their best interest. Registered investment advisers (RIAs) are the most common type of independent broker found today.
Captive brokerages are affiliated with a specific mutual fund or insurance company, and have contracts with specific providers to sell only their products. Therefore, captive brokers may appear biased, as they can be persuaded to recommend and sell the products that the mutual company owns. As a result, brokers may sell clients products that are not in their best interest. Nevertheless, many captive brokers are also fiduciaries and are supposed to legally have the client's best interest - and not their own - in mind.