The first step that you need to take to begin investing, is to open an investment brokerage account. An investment brokerage account is similar to a bank account but instead of simply holding cash in the account, you are able to use the money you deposit to purchase investments. Some banks offer brokerage services in addition to banking services. However, most of the banks that do this are not very competitive when it comes to the fees that they charge in the investment account.
In this post we’ll discuss the key factors which you want to look into when choosing your investment brokerage account. First I will discuss different types of brokerage accounts. Then, I will discuss each of the following major points you should consider when choosing a brokerage account in order of importance. Fair warning, this guide is somewhat long.
- Trading choices
- Investing expenses
- Research tools and real-time quotes
- Methods of trade execution
- Additional features which make investing easier, simpler, or cheaper
Types of Brokerage Accounts
There are three major types of investment brokerage accounts: Full-service brokers, discount brokers, and specialty brokers. Full-service brokers have the highest level of service but they also charge the highest level of expenses. With a full service broker, you usually have access to a live person to help you make investing decisions. This service doesn’t come cheap though. You can expect to pay an order of magnitude higher to buy and sell stocks than if you had simply bought them yourself. That is why, I recommend either a discount broker or a specialty broker.
A discount broker, is fairly simple. They provide limited services, but much cheaper trades. You can usually expect a discount broker to provide a platform for you to make investments, some research tools, quotes, and basic portfolio management information. The rest you’ll have to figure out on your own. I recommend Scottrade as my favorite discount broker. They are the primary broker that I use for my own investments.
Specialty brokers tend to be similar to discount brokers but have some unique features. Each broker in this category is unique and they offer different services and costs for their accounts. Vanguard is a specialty broker that specializes in index and mutual funds. They offer the lowest cost and highest quality funds, which is why I recommend them for those seeking to only invest in such funds. Motif Investing is a specialty broker that specializes in individual stocks. They allow you to create your own index/mutual funds or invest in those made by others. They are my highest recommended provider for those seeking to only own stocks.
Trading choices can be broken down into different sections:
- Security Type – Stocks, Bonds, Derivatives (such as Options), Mutual funds (which include index funds, both stock and bond), and ETFs.
- National Affiliation – United States based or international based companies
Security type is fairly simple. You want to make sure that whatever brokerage account that you choose gives you the ability to trade all of the types of securities which you want to trade. If you only want to own stocks, and have no interest in the others, then you don’t need a brokerage account with a lot of options for mutual funds, or the ability to trade bonds. If you are only interested in owning mutual funds, then you should choose a brokerage that specializes in mutual funds and not individual stocks or bonds.
National Affiliation is whether you are content to only purchase US based companies or if you also want the ability to purchase foreign companies in foreign currencies. My personal opinion is that for the vast majority of people, being able to purchase international stocks is completely unnecessary. The point of owning international stock is to have exposure to companies who sell in international markets. Due to the fact that many of the worlds largest and most profitable multinational companies are based in the US, you can receive this exposure without ever purchasing a foreign stock. In addition, many of the international companies which you may like to own, sell shares on US stock markets because the US stock markets are the largest and most reputable in the world.
My personal, primary, brokerage account does not offer the ability to purchase international stocks. I have never found this to be a problem, and I do own some international companies at the time of this writing.
For those of you who would like the ability to purchase international stocks, there are a few countries which you should prioritize. No brokerage account will have access to all of the international markets, so you need to choose which are best suited for you. I recommend having access to the UK, Germany, Switzerland, Japan, and possibly the Hong Kong markets. The rest are less important, and you should be able to buy any of the world’s best companies through those markets. I highly discourage the purchasing of Chinese based companies, or companies that receive a majority of their revenue from operating in China. The reason is that China heavily restricts the ability to move cash out of the country and they do not have the same level of scrutiny for audited bookkeeping. This can lead to profits being overstated and is a definite risk for those investing in China.
Your goal should be keep investing expenses to an absolute minimum when choosing an investment brokerage account. Here is a list of many of the most common investing expenses which you might incur related to your brokerage account. Some are only relevant for certain investing strategies. The important thing is to minimize the expenses that are related to your specific investing strategy and not worry about those which you will never have to incur.
- Trading Fees – This is the most applicable fee for stocks, bonds, and options. This is a fee that is incurred when you purchase or sell a security.
- Sometimes you will have a fee for buying or selling a mutual fund or ETF, but the best mutual funds and ETFs have no trading fees.
- Discount brokerage accounts will have low trading fees. This will usually be less than $10 per trade. Full service brokerage accounts will tend to have much larger trading fees. These could be $50, $100 per trade or more.
- Account maintenance fees – With the exception of HSA accounts, nearly all brokerage accounts have zero account maintenance fees. If your brokerage is charging you a fee to have an investing account with them, you should switch to a new broker.
- Expense Ratios – This is the most applicable fee for mutual funds and ETFs. This fee is charged constantly while you own a fund as a percentage of the total assets you have invested in the fund.
- This fee should only be considered with regards to choosing a brokerage account if your broker has exclusive mutual or index funds and that is your reason for choosing that broker. This is most common for specialty brokers.
- The average mutual fund expense ratio is between 1-2%. Some mutual funds have expense ratios as low as 0.02%. You should not invest in any funds that have an expense ratio over 0.50% and I would recommend only investing in funds that have expense ratios below 0.25% if at all possible.
- Advisory fees – This is a fee which you pay to someone to manage your investment funds for you. This fee is usually charged as a percentage of the total assets which someone is managing for you, but it can be charged as a flat rate. This fee could also be called a wrap fee.
- I believe this fee is unnecessary for most people, especially for those reading this website.
- This fee will frequently be charged between 1-2% of your total investment assets every year, which will likely cost you hundreds of thousands of dollars or more over the course of an average lifetime.
- Misc. Fees – These are additional fees related to the servicing of the investment account. Examples can include:
- Account closing fee – Fairly common. Not a large concern because hopefully you choose a brokerage account which you plan to continue to use for many years. This fee usually ranges from $25-100.
- Research fees – If the brokerage is required by law or by your personal request to research your account history for whatever reason, this fee will be charged. The fee is usually charged at an hourly rate. This fee is fairly common, but I have never seen it used.
- Other fees may exist but I can’t mention them all. Be sure to read over the full fee listings for your broker when signing up for an account. The lower your fees; the higher your investment returns.
Research Tools and Real-time quotes
Passive and Active Investors will need to worry less about research and real-time quote availability than DIY Investors. The reason is that passive and active investors will tend to establish a set investing plan upfront and have little need for ongoing research. Quotes are important, but you don’t need real time quotes unless you actively trade. I recommend that only DIY investors engage in active trades based upon intra-day changes in price.
If you want research information, there are some important types to consider. The first and most simple is some sort of stock/bond/fund screening tool. This tool would allow you to sort between stocks based upon a set of metrics which you choose. Possible metrics could include fundamentals such as P/E ratios, or dividend yield. Alternatively, you could use technical indicators such as moving averages and signals. I focus mainly on fundamental analysis, but will address technical trading as well at some point.
The alternative to real time quotes are static quotes based upon the prior day’s closing price. This is sufficient for any sort of investment fund. Index funds, mutual funds, ETFs, etc… This will also be sufficient for passive and active investors even if they are buying individual stocks and bonds.
Another type of research information is analyst reviews. There are a few companies which provide analysis on companies on a regular basis. Some examples are Thomas Reuters, Market Edge, and S&P Capital IQ. I don’t generally rely on statements by analysts when making investment decisions but they can be useful. They are especially useful to get a brief overview of a company before commencing a more in-depth analysis on your own.
A third source of research information is historical data. This can come in the form of charts or tables of company performance. Charts are especially useful at gaining a quick overview of how the stock price of a company has performed in the past. Past performance is no guarantee of future performance. However, past changes can give you some insights into a company.
Other forms of research tools exist, and you’ll find a myriad of them. The important thing is to make sure that the brokerage account you choose has the resources you need to be a successful investor. You will also be able to perform research outside of your brokerage account, and sometimes the most valuable research can’t be done through your broker.
There are three aspects of how your trades are executed that are worth consideration: time, method, and speed of execution.
Do your trades execute at the end of the trading day? If so, they will be based upon the closing price. This can result in a buy or sell price which is materially different than the price at which you entered the trade. Does the trade execute immediately or does it let you choose when it executes? The benefit of immediate execution is that if you have real time quotes, you can predict the actual trade price fairly accurately.
What types of trade orders are you allowed to make? Is your only option to choose market orders? Are you allowed to make limit, stop, or other order types? Market and limit are the main two which are worth considering. Passive and active investors only need to worry about market orders. These will tend to execute at the end of the day, as mentioned above. DIY investors will want to at least have access to limit orders as an alternative.
Speed is not a major issue and isn’t something you should worry about too much, but it is a factor in trade execution. A trade order that executes faster is more likely to receive a better price. The difference is usually no more than pennies per share but this is how the rise of high frequency traders has occurred. They focus on making pennies repeatedly by just executing trades the fastest. Most brokers have sufficient execution speed, but you could use this as a tiebreaker if you are aware of one being much faster than another and all other features are equal. Please note, it is unlikely that this information will be easy to find.
There could be a whole range of things to consider as additional features. Some of my favorites include:
- Dividend reinvestment – The ability to reinvest dividends directly back into the stocks that paid them, without any fees.
- Free Trades – Some brokers provide free trades for certain actions or meeting specific criteria.
- Pooled Investment methods – Either the ability to pool dividends from multiple stocks into a single purchase, or to pool investment money into many purchases for only a single fee.
- Partial share purchases – This is frequently used in combination with either dividend reinvestment or pooled investments. The idea is that you can purchase whatever amount of a share your dividend would provide, even if it isn’t a full share. Ordinarily trades can only take place for full shares.
Sometimes you will even have combinations of the above features which combine the best points of each. None of these features are necessary but they can be nice bonuses.
There are many different factors to consider when deciding upon an investment brokerage account. It is important to weigh each of the factors which I have laid out above when making your decision. Remember that there is no single best brokerage account for everyone. Your investor type and investing plan will greatly influence what you want from a brokerage account provider. You can review my recommendations for investment brokerage accounts on my resources page. The page is still being updated and more brokerage accounts will be added along with full reviews and investing strategies for each, as I am able to make a full determination of what accounts best fit each type of investor. In the meantime, I encourage you to consider the factors that I wrote about here, when determining which provider best suits your needs.
Please comment with the name of the brokerage account provider that you use, or plan on using, along with your investor type in the comments below. This will only help others to better make their own decisions.