A Beginners Guide to Making Money (2018)
Now hold your breath and get ready to jump in. You’re about to pick a brokerage and enter the stock market!
There are two basic types of brokerage: full-service and discount. While they are different from each other in many ways, they have one big thing in common: all brokers make their money from commissions.
This means that every time you make a trade (buying or selling), your broker takes a fee. Typically, the fee is based on a fixed rate for each individual trade, but there are also other ways of charging a commission.
Each type of brokerage has its strengths and weaknesses for the novice investor…
You probably won’t be surprised to discover that full-service brokers offer, well, full services. That means they’ll do a lot more than just execute your trades for you. With a full-service broker, you can talk one-on-one with an advisor. They’ll know your name. They’ll understand your goals. And they’ll provide you with research on individual stocks, investment advice, retirement planning and a whole lot more.
And all that assistance isn’t something just for the ultra-rich who can afford diamond-studded collars for their pet albino tigers: it can make a real difference for the ordinary Joe. For example, full-service brokers can offer you advice on taxes that you might otherwise not know about—and that could save you a lot of money.
But of course full-service brokers also cost you money, too: you don’t get all those services for free. With a full-service broker you will pay more for your trades—often a lot more. In addition, full-service brokers can sometimes require investors to have a minimum balance that puts them out of the reach of the ordinary Joe…
Choosing between discount and full-service requires you to understand yourself and your needs. If you’re starting out, maybe you don’t have the confidence to go it alone. In that case, a full-service broker might be best for you, since they can hold your hand and guide you through the process.
On the other hand, if you’ve completed Wall Street Survivor’s basic courses, you should have faith in yourself. With a solid understanding of investment principles (remember: diversify, diversify, diversify!), you may not need the advice of a professional. After all, if you’re just starting out, you may not have a lot to invest—and in that case, how much advice can a full-service broker really give you?
Costs Add Up
Remember also that the smaller your portfolio, the larger the brokerage fees as a proportion of your investment. With a full-service brokerage, the difference charged for a trade can really add up. Full-services trades can be five, 10 or even 15 times more expensive than discount trades. Even if you want to have all that extra advice, you have to ask: can I afford it?
And there are other things to consider. For many brokerages you have to have a minimum amount to invest. And if there isn’t a minimum (or even if there is), in some cases there is an annual fee that can be 1% or more of your portfolio. (Watch out for full-service brokerages that offer “unlimited free trades,” because they will almost certainly charge you an annual percentage fee. After all, they have to earn a living somehow…)
Full-Service Brokerage: Caveat Emptor
And finally, remember that old Latin saying: Caveat Emptor, or Stock Investor Beware! (Something like that…)
When it comes to discount brokers, that saying generally doesn’t apply. All they do is open an account for you and execute trades—the rest is up to you.
With a full-service broker, however, you have to be a bit more careful. As we said before, full-service brokers—like all brokers—typically get a fee every time they execute a trade on your behalf. Do you see a problem here?
If full-service brokers are making money off your trades, that means they have an incentive to see you trade more. In addition, they may make even more money if you buy a product their own company is selling, like a mutual fund.
That creates a conflict of interest that you need to be aware of. If you decide to go with a full-service broker, always ask how they are compensated. If they are fully or partially on commission, you should make extra effort to ensure that they will always represent your best interest, not theirs.
The Pros and Cons of Full-Service and Discount
So, to wrap up the differences again, here is how the two types of brokerages stack up:
The Right Broker for your Investment Style
Lastly, you want to look at the kind of investor you are. Do you want to do research on your own? Are you comfortable making your own investment decisions? Do you like to follow new trends in the market, or just stick with reliable, old-fashioned stocks? All those things can help determine which kind of brokerage is right for you.
Here are three types of investors to consider:
If you think you’ll trade a lot, it’s advisable to choose a discount broker, for two reasons:
- Active traders are generally informed traders. You shouldn’t be making lots of trades just because you like to gamble. And if that’s the case, you probably don’t need to rely on a broker for advice.
- Active trading is very expensive with a full-service broker. If you’re making trades every few weeks (or even more often), the fees you pay will add up very quickly. That will diminish your return, which defeats the whole purpose of active trading.
Maybe you’re content to buy a portfolio and then just rebalance it once or twice a year. If that’s the case, you could be happy with either a full-service or a discount broker. With a full-service broker, high fees on transactions won’t matter much, because you may only be making three or four trades annually. And with a discount broker, those fees will be even less. In that case, your decision should be based on what other fees the brokerage charges (such as an annual fee) and what kind of advice (if any) you think you’ll need.
Buy and Hold Investor
If you’re like Warren Buffett, who likes to research a company to death and then pick a portfolio that he holds onto for eternity, again it won’t matter too much what kind of brokerage you choose. Since you won’t be selling your stocks until you’ve moved into a retirement home, who cares how much you paid to buy them 60 years earlier? A full-service brokerage could be right for you.
But on the other hand, presumably you’ve decided to buy and hold because you’ve done mountains of research on those stocks that you’re buying and holding. If so, you clearly don’t need an investment advisor to tell you what stocks to buy, so why not save yourself a few dollars and go discount? Either way, it won’t make too much difference over the long run, unless you’re with a broker who charges fees over and above those for trading.
Some of the Best Brokerages
We’ll round everything up by looking at some real-life examples. There’s an endless number of brokerages to choose from, but we’re going to look at just four. And for the purposes of comparison, we’ll only look at online brokerages. (Since you’re online right now, we assume you’re comfortable doing your investing this way too.)
#1 TD AMERITRADE
#4 INTERACTIVE BROKERS
And Now You’re Ready to Go!
Once you’ve decided on a brokerage, all that remains is to call them on the phone or set up your account online. Send them your money and you can start building a real portfolio right away. It’s that simple. You are now, officially, a bona fide investor. Congratulations!