Comparison: On-Line Discount Brokers 2005

Since last year, the number of brokers featured in our survey has fallen from 54 to 47, continuing the consolidation trend of the past three years. Many brokerage firms were forced to merge or be acquired by other firms as well as cut costs and reduce staff in order to survive.

In the face of reduced revenue and heightened competition, the trend among on-line brokers these past few years has been toward becoming niche players in order to differentiate from the competition. Brokers seeking active stock traders will likely feature a different cost structure, research offerings and order-entry process than a broker acting as a one-stop center for investors seeking banking services, financial planning and management of varied portfolios of stocks, mutual funds, and bonds.

Figure 1. Growth of On-Line Brokers CLICK ON IMAGE TO SEE FULL SIZE.

The bar chart in Figure 1 traces the growth and subsequent decline in the number of on-line discount brokerage firms over the 15-year period since we first began covering them. A big jump took place in 1996, soon after the launch of the first Internet-based broker. All of the on-line brokers in this year’s survey offer Internet trading, although some remain more rudimentary, while others are more advanced.

Figure 2. On-Line Commissions 1991-2005 CLICK ON IMAGE TO SEE FULL SIZE.

Figure 2 depicts the trend in on-line commissions, displaying commissions for a 100-share market order charged by on-line discount brokers over the last 14 years. When discount brokers first ventured on-line with direct dial-up software, on-line commissions decreased slightly. However, the late 1990s saw a significant decline in commission fees, with the average minimum commission decreasing from $40 in 1995 to $20 by 1998. This rapid decline can be attributed to the growing number of on-line brokers and increased competition. Commissions have remained fairly stable since then, with the average commission decreasing slightly from $18.20 per trade in 2003 to $17.50 per trade this year.

Commission rates have settled into three segments closely matching the highest, lowest and average commissions in the chart. Less than one third of the brokers are deep discounters offering market orders below $10 per trade. Full-service discount brokers offering a wide range of securities and services charge about $10 to $30 per trade. Five of the 47 surveyed brokers continue to use commission schedules rooted primarily in a non-flat-rate, pre-Internet world.

The highest commission broker this year continues to be Max Ule at $45.60 for the sample trade of 100 shares and $156 per trade for 500 shares, as shown in the comparison table. Interactive Brokers and MB Trading both charge a penny per share for any order up to 500 shares, making their commission fee of $1.00 for 100 shares the lowest. However, these two brokers are geared toward active traders; brokers with such low fees may have a monthly minimum, charge a monthly fee for trading inactivity or charge for software to allow direct access trading (see the box below for more on direct access brokers). Brokerage firms can generate revenue from many sources beyond commissions, including payment from dealers to execute trades, mark-up between bid and ask prices and lending securities and money.

Because most firms offer low commission rates, it is difficult for brokers to attract customers on price alone. Many are establishing additional features to differentiate themselves—such as research tools, better rates for active investors, after-hours trading, brick-and-mortar brokerage offices and direct order placement. Within the last several years, brokers used research tools and real-time quotes to gain a competitive advantage. However, investors now have access to many free Web sites offering these same features making it almost necessary for on-line brokers to have these services. The comparison grid details these added services and lists associated fees charged, if any.

While the data shown in the comparison grid is supplied to us directly from each broker, always verify the information presented here by contacting the brokers before making any final decisions.

Trading Options

The flexibility of a firm’s trading system is a key component in the evaluation of any broker’s offerings. If the firm’s Web site is down due to heavy trading volume or technical problems and traders cannot access their accounts, other trading venues such as a touch-tone phone service become very valuable.

In this article, on-line trading presupposes access to an Internet connection. The Other Trading Options section of the grid shows alternatives to Internet trading. In addition to being able to place trades via a computerized trading module hosted at the firm’s Web site, brokers may offer touch-tone telephone service as well as hand-held wireless options for investors on the go.

Touch-tone service simply allows trades to be placed over the telephone using the phone keypad. Discounts and commission schedules offered for on-line trading typically also apply to touch-tone trading; about half of the brokers offer touch-tone telephone trading.

Personal digital assistants (PDAs) have become popular tools for contact management and task management, and they are able to handle spreadsheets, basic software applications and games. Today, these handheld PCs have also become the standard for wireless trading, with capabilities allowing for two-way communication throughout the U.S. A number of larger brokers also offer support for trading through Blackberry RIM handhelds. One-third of the brokers offer trading through wireless hand-held systems or Web-enabled cell phones.

Commissions

The Flat-Fee Commission Rate and Maximum Number of Shares columns should serve as the base for any commission analysis. A sample trade of 500 shares at $50 per share is presented, along with what percentage of the total transaction the commission represents, to allow comparison with brokers that do not have flat-fee schedules. The chart also indicates any additional charge for limit orders (set price or better).

For example, Firstrade Securities has a flat fee of $6.95 for a market order without regard to the number of shares traded. An additional $5 fee is levied for trades placed as limit orders. York Securities, a firm that does not use the flat-fee commission schedule, charges $0.02 per share with a minimum charge of $40. This means the commission cost for 500 shares at $50 per share is $40.

No-Load Fund Transactions

The figures entered in the Minimum Fee for No-Load Mutual Fund Transaction column are calculated by figuring the associated commission of purchasing one share at $1.

Securities Handled

All on-line brokers included here handle stock trades, so this is not shown in the grid as a column under securities handled. Most of the brokers allow you to trade other basic securities such as options and mutual funds. Unfortunately, only 11 of the firms in this year’s survey allow individuals to trade futures contracts on-line. This is primarily due to the highly leveraged nature of futures and their accompanying liability concerns. Just over half of the brokers allow investors to trade bonds on-line. With the exception of U.S. Treasuries, the bond market is very fragmented and therefore less suited toward simple on-line order entry systems.

Commission structures vary for different types of securities traded, so be sure to ask for a detailed commission schedule from any potential broker and review it carefully. Most brokers describe basic commissions and fees on their Web site; however, you may have to contact the firm directly for details involving specific situations.

Cash Management Accounts

A cash management account consists of basic banking services within a brokerage account. Cash management accounts offer services such as direct deposit, check writing, wire transfers, debit card usage and sweep account capabilities. Almost two-thirds of the brokers offer a cash management account.

Placing Orders

Most brokers allow basic trades to be placed on-line, such as market, limit and stop orders.

The simplest, the market order, is usually executed immediately at the best available price. Before placing a trade, it is important to first examine the market price by looking at the last trade price and its time of execution, current inside bid/ask spread, size of these offers and volume. While a market order offers the quickest and surest way to accomplish a trade, it comes with the risk that a quickly moving or thinly traded market may lead to a poor execution price.

A limit order reduces that risk by setting the minimum price an investor is willing to sell a security at, or the maximum price that an investor is willing to pay to purchase a security. As mentioned above, the flat-fee commissions are based on entering a market order. The grid indicates any additional fees to place a limit order.

Stop orders are also tied to market moves. While a limit order establishes a set price or better, a stop order becomes a market order when the security’s price hits the stop price. This order will then be filled at the prevailing market price, with no guarantee of a specific price.

Length of time can also be assigned to on-line orders, such as a day order (good through that day only) or good-until-canceled (usually good through the end of the month in which the transaction was placed). Short-selling involves selling un-owned shares of stock. Short sellers hope to profit from stock price declines by borrowing stock and selling it first, then buying the stock later at a lower price and returning the borrowed shares. Brokerage firms have the ability to lend shares held by the broker in margin accounts of other customers.

A do-not-reduce order is an instruction not to automatically reduce a stop or limit order by the amount of the dividend when a stock goes ex-dividend. A versus purchase order is used to specify which lots are to be sold. This helps individuals limit tax liability by allowing them to sell shares that were purchased at a specific price. Just over one-third of the brokers indicated that they handle versus purchase orders.

Once an order is placed, all but two of the brokers allow you to review and change the order on-line provided that the trade was not executed.

Order Confirmations

The section entitled Confirmation of Order Fulfillment Delivered refers to the notification process that a recent order was filled. An order fulfillment confirmation can appear on-line at a designated area on the broker’s Web site, or it can arrive in your inbox as an E-mail message. Confirmations can also come in the form of a telephone call or be sent via regular mail.

In most cases, more than one means of receiving confirmation is available. All of the brokers offer an on-line notification either through an on-line link or via an E-mail message; all but two send out confirmations via regular mail. Over half of the brokers offer to call with a confirmation of the fulfillment of the trade.

Portfolio Data

Immediate access to account information is a huge benefit of on-line trading. It is important for the broker to make this type of portfolio data available and easy to access. It allows investors to see how much cash is available to purchase new securities, as well as to view securities they currently own.

In addition to reporting on the availability of cash balances and positions, this section of the comparison grid also indicates which on-line brokers provide a record of dividends received from your securities and a detailed ledger of your account transactions. Additionally, the comparison grid denotes the historical time period of the transaction ledger available on-line. The reference “since inception” refers to a transaction ledger showing all activity since the account was opened. All but one of the brokers surveyed, Online Brokerage Services, offer a historical record of transactions on-line—ranging from the past month of activity to all transactions since inception.

Three quarters of the brokers allow customers to download transactions into Excel or a dedicated portfolio management software program such as Quicken or Microsoft Money. This can be a great time-saving feature when it works properly. The brokers were also asked how soon portfolio information is updated following a transaction or change in the portfolio holdings or cash account. Real-time (symbolized by RT in the grid) denotes that the portfolio is updated immediately following a change. Intraday (ID) updating is on a delayed basis, such as a 15-minute delay or updated once every hour. End-of-day (ED) simply means that changes to the portfolio would not be reflected in an investor’s records until the next trading day. With roughly one quarter of these brokers, customers can request portfolio updates be periodically sent via an E-mail message (EM).

Open Financial Exchange

A few years ago, CheckFree, Intuit and Microsoft established a common standard to transfer account information among brokerage firms, called Open Financial Exchange (OFX). The purpose of OFX is the electronic exchange of financial data between financial institutions, businesses and consumers via the Internet. As a new question on our survey of brokers this year, 18 reported offering OFX. These brokers store historical trade information on an OFX server that can be imported into portfolio management and tax preparation services and products. Services such as GainsKeeper, Quicken.com and Yahoo! Finance have the ability to import portfolio data from the brokers that offer OFX.

Quotes

Current quotes on securities are a vital part of placing a trade. An investor needs fresh data, no matter how volatile the market, to make informed decisions.

The bid/ask price refers to the spread between the highest price bid to purchase and the lowest price offered to sell a stock. Last trade denotes the price at which the security last traded. Volume is the total shares of a particular security that have changed hands. The availability of daily price highs and lows as well as 52-week highs and lows is another important feature aiding in determining a security’s relative price standpoint and volatility.

The quotes section is broken down by the type of quotes available—delayed (DY), real time (RT), and Nasdaq Level II (NLII). In the past, real-time quotes were quite expensive and rarely free. Today, real-time quotes are a cost of being competitive with other brokers and free for most customers. Some brokers charge a fee for both real-time and Nasdaq Level II quotes, most often on a per month basis. Since last year, two firms now offer real-time or Nasdaq Level II quotes that previously had not. MB Trading charged customers for real-time quotes in the past but now offers them free. InvestIN Securities lowered the cost of Nasdaq Level II quotes from $12 last year to $10 this year while Sloan Securities raised the fees by $5 for both services to $25 per month.

Live Broker Availability

In addition to touch-tone or wireless trading, the availability of “live” brokers adds flexibility to a brokerage firm’s trading system. On-line brokers maintain a staff of live brokers to take orders over the phone.

This service is different than a touch-tone function in that orders are placed with a real person. In some cases, commission fees are higher for this type of broker-assisted trade.

After-Hours Trading

Slightly more than half of the on-line brokers offer their clients access to the markets before the open or after the close via after-hours trading sessions.

After-hours trading utilizes computerized order matching systems known as electronic communications networks (ECNs). These sessions are completely independent from standard market hours trading. The trading interface is usually different and only special after-hours representatives can take orders. After-hours sessions mostly occur after the markets close and in some cases early in the morning, before the markets open.

A certain degree of liquidity must be present for a security to be traded during these after-hours sessions. Most Nasdaq 100 stocks and heavily traded New York Stock Exchange stocks are eligible candidates. There are limitations on the types of orders and size of orders that can be placed. Specific guidelines and rules differ from broker to broker regarding after-hours trading. The key for individual investors is finding another investor to fill the other end of the trade at a favorable price.

Research

To provide more detailed and consistent information about the free research on-line brokers provide, a list of specific services and capabilities is included. The categories of free research offered on-line include fundamental data, analyst reports, screening, charts, news and the newly added historical price data, which is offered by 24 companies. Free company charts and news are more common than free stock or mutual fund screening.

Trading Demo

Most of our readers are familiar with how demonstration versions of software applications work. A potential user requests a demo copy, allowing the user to test the features and functionality to gauge the ease-of-use of a program before committing to buy it.

Many on-line discount brokers are taking the same approach with regard to the proprietary trading modules on their Web sites. Some demos allow the order fill process to be experienced, while others are simply slide shows illustrating the process.

In any case, this is an invaluable feature that unfortunately is not offered by all the brokers in this comparison. The column reporting those firms that offer a trading demo appears at the end of the table and wraps up the comparison grid.

Support

If you are in the process of reviewing several on-line discount brokers as possible trading service providers, the issues covered create a good foundation on which to build. One area that all potential customers should consider—but that is hard to quantify in a comparison—is the type and quality of support received when problems or questions arise. When test driving any broker, focus on the firm’s phone support and E-mail responses. Be sure to call prospective brokers and ask the representative any and all questions, request literature detailing services and fees, E-mail the firm the same questions and be sure to browse their Web site for general information. Compare the information received from each of these sources for consistency.

Also, consult friends and peers with experience in on-line trading or those who have just shopped on the Web before. And finally, check out the on-line trading discussions in chat rooms and on message boards.

Voicing Your Opinions

AAII maintains a questionnaire at AAII.com for member input on the on-line discount brokers. This questionnaire gives our readers a chance to share their trading experiences and observe what others are thinking. The questionnaire has been very popular; we are pleased with the response over the last few years. The accompanying box below reports the results of this survey over the past five years.

If you have worked with an on-line brokerage firm in this year’s comparison, please take a minute to log onto AAII.com and answer a few questions and share your experiences. The questionnaire can be found under Member Surveys. Again, as in years past, results are posted and continually updated. All responses will remain anonymous.

AAII Members Rate the On-Line Brokers The Member Surveys area of the AAII Web site offers members the opportunity to voice their opinions on a variety of topics including discount brokers. Specifically, we asked which discount broker you use, the primary reasons for choosing your broker and how satisfied you are with them. A summary of the past five years of results is shown in Table 1, which presents the ratings of the most popular brokers based on member responses since 2000. Results are ranked based on the percentage of members using each broker. From 1999 until 2002, Charles Schwab was the most-used broker among members responding to the survey. In the last two years, its dominance has waned, falling from 21.2% in 2002 to 14.6% last year, tying Scottrade for the number one spot. This year, Scottrade is the most used broker with 21.1% and Charles Schwab falls to third with 13.7%. Scottrade did not rate among the top five brokers until 2002, placing fifth. Table 1. Ratings of Most Popular Brokers CLICK ON IMAGE TO SEE FULL SIZE. The top brokers continue to serve a greater number of our members than they have in years past. In 2000, the top five brokers accounted for a little over half of the total responses. The figure has grown every year for the past five years. This year, the number grew five percentage points from last year to 67.2%. This may be an indication of the consolidation that has swept through the industry over the last few years. Table 1 also provides ratings for each broker in four areas: overall satisfaction, service reliability, trade price and execution speed. Service reliability refers to the ease with which you are able to access your broker via the Web. Trade price takes into account the price at which on-line orders are filled relative to your trade price expectations. Execution speed refers to how quickly an on-line order is filled. Charles Schwab and TD Waterhouse rank at or near the bottom of each ratings category this year. Meanwhile, Scottrade rates at or near the top of each category. This, along with its commission structure, may explain its ascendance to the top in terms of member use. Table 2. Primary Reason Members Selected Their Broker CLICK ON IMAGE TO SEE FULL SIZE. Table 2 shows the changes in the importance of factors members take in to account when selecting their broker. In 2004, as in every year, commissions are the key factor. In the past, broker services declined in importance over the years, while convenience rose as a selling point among our members. This year, however, as commissions rose higher in importance, services and convenience fell. This is probably a result of competitive pricing among brokers to attract new clients and the almost identical services offered by most on-line brokers today. Overall, the results of the survey show the changes that have taken place in the industry over the years. They also illustrate the changes among investors themselves and what they feel is important when selecting a discount broker. To participate in the broker survey for 2005, go to the Member Surveys area, found under Community on AAII.com.