Comparison: On-Line Discount Brokers 2008

In the past, mergers and acquisitions have played a big part in shrinking the number of firms included in our list of on-line discount brokers each year. In 2002, AAII’s On-Line Discount Broker Guide included 77 on-line discount brokers. In 2003, there were 62; 54 in 2004, 47 in 2005, 46 in 2006 and 47 last year. The list is smaller this year again, with only 44 on-line discount brokers participating. Six new firms joined the group this year: eOption, JetTrade.com, LowTrades.com, SogoTrade, Thinkorswim and Wang Investments. Nine firms were eliminated from the group this year, as well. Some merged with other firms (CyberTrader merged with Charles Schwab and Accutrade merged with TD Ameritrade), and others chose not to participate in the listing this year.

The bar chart in Figure 1 traces the growth and subsequent decline in the number of on-line discount brokerage firms over the last 16 years. A big jump took place in 1996, soon after the launch of the first Internet-based broker.

Although it looks as though the consolidation trend is cooling, some larger firms are still picking up smaller brokers. While these mergers may benefit investors who use smaller brokerage firms because of the extra services and cheaper commissions offered by a larger firm, many customers of merged and acquired firms can be frustrated with the new firm. While there will always be hiccups as firms transition, keep in mind that you are not obligated to stay with the new firm. If the commission schedules are costing you more or service is not up to par with what you need, there are plenty of other options out there.

Keeping sensitive client information safe from hackers was a big issue over the last year. After the highly publicized security breech at TD Ameritrade and E*Trade, many brokerage firms stepped up security efforts and made investors aware of additional steps they should take to help keep their sensitive information safe.

A typical scam involves hackers obtaining data from public computers. An obvious way to evade such a scam is to not use public computers to make trades. E-mails directing you to a fake Web site (it may look real) to verify password and account information are also used to obtain personal information. Never go to a broker site via a link in an E-mail.

During the second half of this year, the sub-prime mortgage debacle seemed to be the topic of many analysis reports and investor conversations.

In October 2007, in fact, E*Trade customers got a big shock when the company announced that it took a $58 million hit in the third quarter due to large losses on home-related loans. E*Trade got into the mortgage business to drive earnings growth and balance the volatility of its stock brokerage service business.

After more unrest in the financial markets and buy-out speculation surrounding E*Trade, a Citigroup analyst wrote in a report that, given the company’s troubles, “customers may withdraw assets, and ask questions later.” The analyst also said that E*Trade had a 15% chance of being forced to file for bankruptcy protection. On the same day, E*Trade announced that the SEC was looking into its mortgage holdings. Representatives at E*Trade are not concerned and point out that customer accounts are insured up to $500,000 by the Securities Investor Protection Corporation (SIPC) and the firm offers additional insurance for clients as well. While this is probably not a cause for immediate concern among E*Trade users, you should pay close attention to the firm and its announcements over the next months to determine if it is still a broker that can offer you the safety and security you need as an investor.

This also serves as a reminder of the importance of thoroughly checking out a broker and its business practices before trusting your money and sensitive information to the firm.

Many on-line brokers are niche players catering to a certain investor. Brokers seeking active stock traders have 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 portfolio management.

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

Figure 2 shows on-line commission trends for a 100-share market order. As discount brokers first ventured on-line, these commissions decreased slightly. The late 1990s, however, saw a significant decline in commission fees, with the average minimum commission decreasing from $40 in 1995 to $20 by 1998. The rapid decline can be attributed to the growing number of on-line brokers and increased competition. Commissions have remained stable in recent years; this year the average commission dropped only slightly from $14.54 per trade in 2007 to $14.49 per trade this year.

Figure 2. On-Line Commissions 1991-2007 CLICK ON IMAGE TO SEE FULL SIZE.

Commission rates have settled into three segments closely matching the highest, lowest and average commissions in the chart. About 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. Four brokers continue to use a no-flat-rate commission schedules rooted in the pre-Internet world. Sixteen of the brokers who charge a flat-rate offer unlimited shares at the flat-rate. The most common maximum is 1,000 shares at the flat rate; LowTrades sets their maximum at 500,000 shares and Trading Direct will trade up to one million shares at the flat rate.

The highest commission broker this year for our sample on-line trade of 500 shares of $50 per share stock is Saturna Brokerage Services, charging $62.50. The lowest is Zecco.com, which charges no fee for up to 10 trades per month for those with account balances over $2,500. They charge $4.50 per trade after 10 trades in each month. Last year, Zecco.com offered up to 40 trades per month and up to 10 per day free.

Brokerage firms 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 brokerage firms offer low commission rates, it is difficult to attract customers on price alone. Many brokers have additional features including research tools, better rates for active traders, after-hours trading, direct access trading (see the box on page 18 for more on direct access brokers), and brick-and-mortar brokerage offices. In the past, research tools and real-time quotes were used to gain a competitive advantage, but now investors can access these tools on various financial Web sites—some free—making it necessary for on-line brokers to offer these services to stay competitive. The comparison grid starting on page 12 details these services and lists any fees charged for quote services.

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

A flexible 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 you can’t access your account, other trading venues such as a touch-tone phone service become very valuable.

Scottrade users had a rude awakening on December 17, 2007, when the broker’s Web site was not working and many calls went unanswered at the call center.

Some traders find it helpful to have multiple brokers, so if one site goes down they can still trade on another. This is also a good reason to look at various order types (discussed in more detail later). If you have placed a market order and the firm is having a technical glitch, you may not be able to cancel that order if the price rises or falls to an inappropriate level. A limit order could get around some of this, but if the site is down, no trades are going through.

In the comparison grid, the Other Trading Options section shows alternatives to Internet trading. Fourteen brokers offer trading via touch-tone telephone service. Touch-tone service 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.

In addition to placing trades through the firm’s Web site with a computer, some brokers allow you to trade on-line using personal digital assistants (PDAs) and cell phones. For investors on the go, these have become the standard for wireless trading. A number of larger brokers also offer support for trading through Blackberry RIM handhelds. Fifteen of the brokers offer trading through wireless hand-held systems and Web-enabled cell phones.

Commissions

The Flat-Fee Commission Rate and Maximum Number of Shares at Flat Rate columns should serve as the base for any commission analysis. If the broker does not offer a flat-rate schedule, then “n/a” appears. A sample trade of 500 shares at $50 per share is presented, along with the 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, MB Trading—a firm that does not use a flat-fee commission schedule but instead has a variety of commission schedule choices for customers—charges $0.01 per share for the first 500 shares and $0.005 per share thereafter. This means the commission cost for 500 shares at $50 per share is $5. Investrade Discount Securities offers a flat rate of $7.95 per trade with no limit on how many shares are traded. The firm also charges an additional $4 for limit orders.

No-Load Mutual Funds

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 of the brokers included in our list handle stock trades. The Other Securities Handled section of the grid shows that 21 of the firms allow you to trade bonds. With the exception of U.S. Treasuries, the bond market is very fragmented and therefore less suited toward simple on-line order entry systems. Most of the brokerage firms (31) allow you to trade mutual funds, and all but one (SogoTrade) to trade options. Only nine of the firms in this year’s survey allow the trading of futures contracts on-line. This is due to the highly leveraged nature of futures and their liability concerns.

As fee structures vary for different types of securities, 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 and can include services such as direct deposit, check writing, wire transfers, debit card usage and sweep account capabilities. Almost three-fourths of the brokers offer a cash management account.

While space does not allow us to list the interest rate that each firm offers on idle cash held in an account, this may be an important consideration when choosing an on-line discount broker, especially if you hold a significant amount of cash at any given time. You could be forgoing significant interest income. Therefore, before committing to a broker, it is a good idea to check the company’s policies and procedures relating to cash held in an account.

Placing Orders

The simplest type of order to place when trading stocks is a market order. This is not included in the chart, as this is the most common order type and all firms allow for this order. A market order is 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 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 this 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. All brokers in our list allow for limit orders; six firms charge extra for this order. The flat-fee commission rates in the table are based placing market orders. The grid indicates any additional fees to place limit orders.

Stop orders are also tied to market movements. 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.

New to our guide this year is the trailing-stop order. A trailing-stop sell order sets the stop price at a fixed percentage below the market price. If the market price rises, the stop-loss price rises proportionately by the trail amount, but if the stock price falls, the stop-loss price doesn’t change. This technique allows an investor to set a limit on the maximum possible loss without setting a limit on the maximum possible gain, and without requiring you to monitor the open order on an ongoing basis. Trailing- stop buy orders are the mirror of trailing-stop sell orders and are used in falling markets. Twenty-three firms allow for this order type.

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 earn a profit when the 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. 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 Confirmation of Order Fulfillment Delivered section refers to the notification of a recently filled order. An order fulfillment confirmation can appear on-line at a designated area of the broker’s Web site, or it can arrive in your inbox via E-mail. Confirmations also come in the form of a telephone call or can be sent via regular mail.

In most cases, more than one means of receiving confirmation is available. All but one of the brokers (Zecco.com) offer an on-line notification either through an on-line link or via an E-mail; all but three send out confirmations via regular mail. About 30% 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. Easy access to this data allows you to see how much cash is available to purchase new securities and the positions of securities currently owned.

In addition to reporting on positions and values, 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 firms offer a historical record of transactions on-line. Ten on-line discount brokers offer a record of all transactions since inception.

Most of the brokers allow customers to download transactions into Excel or a portfolio management software program such as Quicken or Microsoft Money. This can be a great time-saving feature when it works properly.

Open Financial Exchange

CheckFree, Intuit and Microsoft have adopted a common standard to transfer account information among brokerage firms. Called Open Financial Exchange (OFX), it allows the electronic exchange of financial data between financial institutions, businesses and consumers via the Internet.

Nineteen brokerage firms reported offering OFX this year. These brokers store historical trade information on an OFX server that can be imported into portfolio management and tax preparation services and products. However, the amount of data each provides varies, so you may still have to manually enter data. Furthermore, the accuracy of their data may sometimes be suspect. Services such as GainsKeeper, Quicken.com and Yahoo! Finance have the ability to import portfolio data from the brokers that offer OFX.

The brokers were also asked how soon a customer’s portfolio information is updated following a transaction or change in the portfolio holdings or cash account. Real-time (RT in the grid) means portfolio data is updated immediately following a change. Intraday (ID) updating is performed on a delayed basis, such as on a 15-minute delay or updated once every hour. End-of-day (ED) simply means that changes to the account portfolio are not reflected in an investor’s on-line records until the next trading day.

Quotes

Current securities quotes are a vital part of placing a trade. To make informed trading decisions, you need up-to-date data. 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 in determining a security’s relative price standpoint and volatility.

The quotes section is broken down by the type of quotes offered—delayed (DY), streaming real-time (ST RT) real-time (RT), and NASDAQ Level II (NLII). Streaming real-time quotes give you a continuous stream of updated bid and ask prices versus real-time, which means having to manually refresh for the most recent bid and ask prices. All but three firms offer real-time quotes, 30 offer streaming real-time quotes, 18 for free. In the past, real-time quotes were expensive and rarely offered for free. However, they are now a cost of being competitive, and 37 firms offer real-time quotes for free. Fees for streaming real-time, real-time and NASDAQ Level II quotes are most often charged on a monthly basis. Three firms—Cambridge Discount Brokerage, First Financial Equity Corp., and Wang Investments—provide only delayed quotes.

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. In some cases, commission fees are higher for this type of broker-assisted trading.

After-Hours Trading

Slightly more than half of the on-line brokers offer 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 have close; in some cases, they may take place 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. The key is finding another investor to fill the other end of the trade at a favorable price.

Research

A list of specific services and capabilities we feel are important to investors has been compiled for comparison purposes. The categories of free research offered on-line include portfolio tracking, news, charts, historical price data, stock and mutual fund screening, fundamental data, earnings estimates, analyst reports, and mutual fund ratings and performance data. Free company charts and news are more common than free stock or mutual fund screening.

Trading Demo

A demonstration version of a software program allows you to test the features and functionality and gauge the ease-of-use before committing to buy it. Many on-line discount brokers offer demos of their trading modules on-line. Brokers who offer a trading demo give potential customers access to a sample of the site’s trading area where they can test drive the site and see how user-friendly the module is. Some demos allow information to be entered, buttons to be clicked and the order fill process to be experienced, while others are simply slide shows illustrating the process.

Either type of demo is an invaluable tool and is offered by 34 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 here help to 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. Focus on the firm’s phone support and E-mail responses. Be sure to call prospective brokers and ask the representative questions and request literature detailing services and fees. E-mail the firm the same questions and be sure to check their Web site for general information. Compare the information received from each of these sources for consistency.

Consulting friends and peers with experience in on-line trading is a great way to get honest feedback about a potential brokerage firm. And finally, check out the on-line trading discussions in chat rooms and on message boards.

Voicing Your Opinions

For the past several years, we have offered a survey for AAII members regarding on-line discount brokers. The on-line questionnaire gives you a chance to share your experiences and learn how other members feel about their on-line brokers. The results of this survey over the past five years can be found on page 6.

If you have worked with a broker in this year’s comparison, please take a minute to log on to AAII.com and answer a few questions and share your experiences. The questionnaire can be found under Investor Surveys. Again, results are posted and continually updated. All responses are anonymous.