Who You Trade With Does Matter

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As an investor, you spend most of your time figuring out which investments are most likely to make you rich. What may surprise you is just how big a difference picking the right broker to trade with can make to your net results.

When it comes to discount brokers, a lot of investors figure that one is just as good as another. But depending on what types of investments you make, what information you need, and how often you expect to trade, making the wrong decision may not only cost you a whole lot more but may even lock you out of promising opportunities entirely.

The bottom line for stocks
The easiest way to compare brokers is on cost. Among discount brokers, the raw commission cost on stock trades has narrowed to the point where the differences are fairly insignificant to those who don't trade all that often. In the past, Charles Schwab (NYSE: SCHW  ) and Vanguard charged as much as $20 to $25 for commissions, while competitors Scottrade, TD Ameritrade (Nasdaq: AMTD  ) , and E*Trade Financial (Nasdaq: ETFC  ) had lower price points for cost-sensitive traders.

The recent price war among major discount brokers, however, has led to a big compression in the differences in commission costs. Now, nearly every broker comes in at less than $10 for a typical stock trade. That's not necessarily good news for the brokerage industry, which has felt the pain from lower trading volume, but from your perspective as a customer, you probably don't need to worry about those commissions breaking your budget. Only if you're a high-frequency trader do tiny $1 commissions from Interactive Brokers (Nasdaq: IBKR  ) and other micro-commission brokers start to make a big difference to your bottom line.

But there's a lot that the basic commission schedule won't tell you. For instance, if you like to buy and sell exchange-traded funds, then commission-free ETF deals from Fidelity, Schwab, and Vanguard are worth a closer look. Similarly, several brokers offer access to certain mutual funds without a transaction fee, allowing you to keep all your assets under the umbrella of your brokerage account without paying up for the privilege.

Better pricing
Stock investors like to get high quality trade executions when they buy or sell shares. With real-time quotes readily available, you can tell what price you should get when you hit the enter button, and if you're routinely getting less or paying more than you expect, then even pennies can add up. Fortunately, most popular stocks have enough liquidity that you're unlikely to get ripped off even by a subpar execution.

Where trading prowess comes into play, though, is with less liquid investments. Individual bonds are a great example, where JPMorgan Chase (NYSE: JPM  ) and other big bond underwriters dominate the market, making it less transparent to individual investors than the stock market. For example, Wells Fargo's (NYSE: WFC  ) Wachovia unit faced a class action lawsuit for allegedly marking up bond prices. But Zions Bancorp's (Nasdaq: ZION  ) Zions Direct has carved out a niche catering to investors interested in bonds, charging a flat fee rather than a per-bond markup or other commission structure. Certainly given the unprecedented interest in bonds lately, you can expect to see more brokers catering to bond investors.

More options
In addition, some brokers are better at integrating a complete investing package than others. For example, nearly every broker does stocks and ETFs well. But what if you want to trade options on those stocks and ETFs? You often won't find commissions for options trades on the front page, but they can vary widely. Plan to trade futures? You'd better check upfront whether a broker you're considering even offers futures at all, let alone at a price you want to pay.

Other factors are important as well. If you really want your broker to offer in-depth research capability, then you'll want to take a test run of brokerage websites to make sure they'll give you what you want. And if you actually want to talk to a human (gasp!), give customer service departments a call -- you'll often get a much different perspective of a broker when you talk to their employees live.

Make the right choice
It's easy to think that one broker fits all, but nothing could be further from the truth. Take the time to get to know your brokerage options. Only then will you have the knowledge base to make your best choice.

Make sure you have the right broker on your team. The Fool's Broker Center will tell you plenty about your options and help you make the best decision for your needs.

Fool contributor Dan Caplinger knows that having the right team behind you makes a huge difference. He doesn't own shares of the companies mentioned above. Interactive Brokers Group and Charles Schwab are Motley Fool Stock Advisor picks. The Fool owns shares of Interactive Brokers Group. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy will always matter to us.

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  • Report this Comment On September 07, 2010, at 3:55 PM, CMFStan8331 wrote:

    "Only if you're a high-frequency trader do tiny $1 commissions from Interactive Brokers... start to make a big difference to your bottom line."

    Actually, the other scenario in which small commissions can make a big difference is for small accounts. The thing is, EVERYONE who opens an IRA will be a small account holder at the start, and if they keep their money in low-yielding investments like CD's until the account gets up over $100,000, it will be a very long wait. With only $5000 (or $6000 for those over 50) going in per year, small commissions can be very significant for retirement accounts in the early years after creation.

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