Get the Skinny on Discount Brokers

Fools with questions on finance -- or just about any other topic -- can often find prompt and helpful answers from the folks on our discussion boards. On our Investing Beginners discussion board, for example, many new posters present questions on a range of topics, from picking the best stocks and funds to choosing a good brokerage firm.

Here are some questions on picking the right broker for you, followed by our responses:

What are some things that I need to look out for when looking for a discount broker?
As we point out in our broker collection, there are a lot of factors you can consider, but the most important ones will vary from person to person. For example, if you have no interest in mutual funds, you won't care about fund-related charges at the brokerage. If you prefer going to a bricks-and-mortar building to deal with your portfolio, you'll want a brokerage with local branches, not an online-only enterprise.

We recommend making a list of what you value most in a brokerage and comparing contenders on those counts. Think about which services you'd use the most, and see what they cost. (Our broker comparison table can help you see how you might construct your own comparison.)

Can a broker that invests in mutual funds invest in any fund family?
First, for those who don't know, a "fund family" is a company such as Fidelity or Vanguard or a host of others that offers several or many mutual funds. The answer here is no. Many discount brokers offer hundreds of funds without any fees, but we don't think there's any brokerage that offers funds from every single fund family out there.

But don't let the absence of a fund you're interested in be a deal-breaker for you if you find an otherwise terrific brokerage. You can usually just buy into the fund from the fund company itself. (It might take a little longer, since you'll have to get necessary forms and send money.)

How do you figure out the entire cost of a trade? Ones I have seen say as low as $8-$10 but they also say you need to make 120 trades a year. What if you don't have 120 trades a year?
Many brokerages' trading commissions apply no matter how many trades you execute during the year. Others offer lower rates if you make more trades, and slightly higher ones if you only trade infrequently.

It used to be that full-service brokers charged commissions based on the amount you invested. Even now, some brokers offer flat fees only for certain numbers of shares or sizes of transactions, and higher costs may apply if your transaction doesn't qualify. For instance, although buying 100 shares of each of these stocks would only cost you between $1 and $30 at most discount brokers, here's what they'd cost at one full-service broker that adds a surcharge based on the value of the shares traded:

Stock

Total Commission to Buy 100 Shares of Stock

Apple (Nasdaq: AAPL  )

$703

Citigroup (NYSE: C  )

$150

Google (Nasdaq: GOOG  )

$1,344

Coca-Cola (NYSE: KO  )

$311

Caterpillar (NYSE: CAT  )

$319

Hewlett-Packard (NYSE: HPQ  )

$292

IBM (NYSE: IBM  )

$489

Source: Broker commission chart.

Obviously, there's a lot to be saved by using a discount broker, especially on stocks like Google, whose shares trade for hundreds of dollars apiece. You really can't afford to use a premium broker that charges rates like these.

In addition to considering the dollar amount of a commission, it's also good to try to keep that figure to 2% or less than the value of the investment. If you're buying $500 of stock, a $25 commission would amount to 5% of its overall value, a big bite. Invest $1,500, and the percentage of that $25 cost shrinks to 1.7%. With a $10 commission and a $500 investment, you're paying just 2%.

Don't have a discount brokerage account yet? Find out why Dan Caplinger thinks it's the best investment you'll ever make. And to learn more, visit our discount broker collection and check out these articles:

This article was originally published on Jan. 5, 2007. It has been updated by Dan Caplinger, who doesn't own shares of the companies mentioned. Google is a Motley Fool Rule Breakers selection. Apple is a Motley Fool Stock Advisor recommendation. Coca-Cola is a Motley Fool Inside Value recommendation and a Motley Fool Income Investor pick. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a full-service disclosure policy.


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