by Christy Bieber | Jan. 29, 2021
Here's what you need to know before you open an account with any broker.
The week ending Jan. 29 has been an interesting one in the financial markets.
Companies long believed to be on the verge of failure, such as GameStop (NYSE: GME) and AMC Entertainment (NYSE: AMC), saw their share prices skyrocket as small traders initiated a short squeeze aimed at wreaking havoc for hedge funds with heavy short positions.
As institutional investors lost billions and GameStop experienced a 1640% increase in the value of its share price, some brokerage firms reacted by imposing new limits on investing in GME and similar companies even barring traders from acquiring new shares altogether.
The actions of these brokers have led to a lawsuit being filed against Robinhood; have prompted lawmakers from both sides of the aisle to call for an investigation; and have left many individuals wondering if their current broker is really the right one.
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While the GameStop phenomenon is an unusual one, problems with brokerage firms can be far too common. For those looking to avoid investing with a broker they end up unhappy with, there are five things you should know before you decide who to open an account with.
The GameStop phenomenon is widely viewed as a David vs. Goliath situation, with retail investors serving as the David to the hedge fund's Goliath.
For the moment, it appears the small investor has scored a blow against Wall Street insiders -- although it remains to be seen if those who made a profit on paper end up keeping their gains by the time the GME ride comes to an end.
Small investors were able to achieve this, in part, because there are more of them than ever -- and that's because brokers have begun removing barriers to investing. One of those barriers is high account minimums.
The bottom line is, you shouldn't need to have tens of thousands of dollars to be able to get started investing, so look for a broker with no minimum balance requirement.
As GameStop's price soared, many small-time investors became interested in getting in on the action -- but shares were trading at a few hundred dollars a piece.
While buying GME during all this frenzied trading is an extremely high-risk endeavor, it's not uncommon for individuals to feel priced out of stock purchases they want to make due to high per-share prices.
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That's why it's so important to pick a broker that allows the purchase of fractional shares. Fractional shares are fractions of shares that you can buy by specifying the amount of money you want to invest in a particular company. They didn't used to be available, as you used to have to buy at least one full share of any business you wanted to invest in.
With fractional shares, if GameStop was trading at $300 per share and you only wanted to bet $100 of your money on this risky Reddit caper, you could specify you wanted to make a $100 purchase and buy just one-third of a share.
Or, if you were looking to make a smarter and safer investment move, you could also opt to buy fractions of shares of companies you'd want to hold for the long term that you'd otherwise be priced out of -- perhaps including Amazon, Apple, Tesla, or Alphabet (Google's parent company).
The GameStop phenomenon was also driven, in part, by the democratization of investing by online brokers that eliminated some of the traditional fees investors have to pay. Specifically, while investors once had to pay a commission of around $5 to $10 every time they wanted to buy or sell shares, most brokerages have eliminated this cost.
It doesn't make sense to buy a small fraction of a share, or even to invest a small sum in full shares, if you're going to lose so much money to commission fees. So be sure any broker you work with doesn't charge you just for buying and selling shares.
Brokers do sometimes charge commissions for certain asset purchases, such as trading options. If you plan to invest beyond just buying stocks, find out about all of the commission fees that could potentially apply.
Traders were outraged when Robinhood and other brokers temporarily shut down the ability to trade GME stock.
This ban on buying shares was an unusual event, though. Unfortunately, with some brokers, a more mundane issue regularly affects their users' ability to trade at will in their account: Their apps aren't stable and there's a lot of downtime.
Although you should buy and hold for the long term if you want to minimize risk, you still don't want to be unable to buy or sell stock because your broker's website isn't working. So before you sign up with any broker, check how often their trading platform has gone down in recent months.
Some brokerages, such as Robinhood, are known for encouraging active trading among young and sometimes inexperienced investors. Others have different reputations (Vanguard, for example, is known for its wealth of mutual funds).
Think about how you plan to invest and how your brokerage will support that. If you want a lot of investor education, for example, look for a broker that's well known for offering that. Or if you're tempted to jump on the YOLO theory of investing (which isn't the best way to build long-term wealth), you may want to steer clear of apps that feed into that tendency.
Ultimately, by considering what a broker is known for, how much it will charge you, and whether it has a solid reputation for reliable service, you can make the right choice about who to invest your money with. Of course, you'll also have to make smart investing choices once your account is open -- which probably means steering clear of GME shares, for now at least.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Christy Bieber has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple, and Tesla and recommends the following options: long January 2022 $1920 calls on Amazon and short January 2022 $1940 calls on Amazon. The Motley Fool has a disclosure policy.
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