On-Line Discount Brokers 2006
by AAII Staff
Heightened competition has led many brokers to become niche players in order to differentiate themselves. 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 management of varied portfolios of stocks, mutual funds, and bonds.
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 depicts the trend in on-line commissions, displaying commissions for a 100-share market order charged by on-line discount brokers over the last 15 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 tended to remain stable over the last few years with the average commission decreasing slightly from $17.50 per trade in 2005 to $17.16 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 on-line 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 on-line trade. Seven of the 46 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 (Figure 2) and $156 per trade for 500 shares (as shown in the comparison table). Interactive Brokers and MB Trading charge the lowest on-line commissions of $1.00 for 100 shares. However, these two brokers are geared toward active traders and may charge a monthly fee for trading inactivity or for software to allow direct access trading (see the box on page 18 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. Most brokerage firms offer low commission rates, making it difficult for brokers to attract customers on price alone. Many offer additional features including research tools, better rates for active investors, after-hours trading, direct order placement, and brick-and-mortar brokerage offices. In the past, brokers used research tools and real-time quotes to gain a competitive advantage, but today individual investors can access these same features on various financial Web sites—some free—making it necessary for on-line brokers to offer 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.
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 through the firm’s Web site via a computer, personal digital assistant (PDA) or even a cell phone, some brokers offer touch-tone telephone service.
PDAs are popular tools for contact and task management and some handle spreadsheets, basic software applications and games, making them essentially handheld PCs. For investors on the go, these have 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. Almost half of the brokers offer trading through wireless hand-held systems and Web-enabled cell phones, up from only one-third in last year’s survey.
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; about half of the brokers offer touch-tone telephone trading.
The Flat-Fee Commission Rate and Maximum Number of Shares 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 on-line 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, Investrade Discount Securities has a flat fee of $7.95 for an on-line market order without regard to the number of shares traded. An additional $4 fee is charged 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 on-line commission cost for 500 shares at $50 per share is $40.
No-Load Mutual FundTransactions
The figures entered in the Minimum Fee for No-Load Mutual Fund Transaction column are calculated by figuring the associated on-line commission of purchasing one share at $1.
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 12 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. 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 three-fourths of the brokers offer a cash management account.
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. A few more than 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.
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 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 of the brokers offer an on-line notification either through an on-line link or via an E-mail; 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.
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 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 (EOD) simply means that changes to the portfolio would not be reflected in an investor’s records until the next trading day.
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. Seventeen brokerage firms 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. On-line services such as Gainskeeper, Quicken.com and Yahoo!Finance have the ability to import portfolio data from the brokers that offer OFX.
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 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), streaming real-time (ST RT), and Nasdaq Level II (NLII). New to the survey this year, streaming real-time quotes differ from real-time quotes in that investors get a continuous stream of updated bid and ask prices versus having to manually refresh for the most recent bid and ask prices. A total of 27 firms offer streaming real-time quotes—17 do not charge for this service. While in the past real-time quotes were expensive and rarely offered for free, they are now a cost of being competitive and offered free to most customers. Some brokers still charge a fee for real-time, streaming real-time and Nasdaq Level II quotes, most often on a per month basis. Four firms—Cambridge Discount Brokerage, First Financial Equity Corp., Securities Research, and Sherry Bruce’s State Discount Brokers—offer 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.
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.
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.
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 portfolio tracking, news, charts, historical price data, screening, fundamental data, earnings estimates, analyst reports, and mutual fund ratings and performance. Free company charts and news are more common than free stock or mutual fund screening.
Many on-line discount brokers offer demos for their trading modules on their Web sites. 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 trading 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.
Demos are offered by 37 brokers in this comparison.
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. Focus on the firm’s phone support and E-mail responses. Be sure to call prospective brokers and ask the representative questions, 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.
For the past several years, we have offered a questionnaire for our members that centers around on-line discount brokers. The questionnaire gives readers a chance to share trading experiences and learn how other members feel about their brokers. The questionnaire has been very popular; we are pleased with the response over the last few years. The AAII.com column on page 6 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 Investor Surveys. Again, as in years past, results are posted and continually updated. All responses will remain anonymous.
|Direct Access Brokers|
A growing trend among on-line brokerage firms is offering investors a direct access brokerage platform. Last year’s survey included 13 brokers offering direct access trading, while this year 16 brokers reported offering the service. Charles Schwab, E*Trade Financial, Investrade Discount Securities, optionsXpress and Regal Discount all joined the list of direct access brokers this year. Direct access essentially cuts out the middle man, making trade executions faster for many reasons. First, the Web interface used by traditional on-line brokers tends to be slower than the software interface used by direct access brokers. Secondly, after an investor places an order through an on-line broker, usually via an E-mail type message, the order is executed by the broker. The broker decides which exchange the order is sent to; usually a pre-determined path for all orders. This multi-step process takes time.
Direct access brokers give investors the ability to send orders directly to the market and choose the exchange the order is sent to, giving more price control. One potential advantage to choosing the exchange is the possibility for price improvement. The order can be sent to the exchange the investor thinks will offer the best price and quickest execution.
For active traders making over 10 trades per month, direct access brokers provide more control over the outcome of trades. Some direct access brokers charge a monthly fee for software. This fee is usually waived or reduced if a certain number of trades are made each month. The highest fee, charged by CyberTrader, is $249 per month and is waived if over 40 trades are placed in the month. Last year the highest monthly fee was charged by A.B. Watley—$300 per month that was waived for over 100 trades per month. This year, the firm lowered charges to $50 per month and waives the fee if more than 10 trades are made each month. myTrack, which charged fees ranging between $19.98 and $95 per month, now offers direct access trading for free. Some brokerage firms only offer the service for free to clients who meet certain trade and balance requirements.
For most firms, commission fees are the same for the direct access broker and the traditional on-line broker. The traditional on-line broker does not charge an additional exchange fee to the investors because those costs are factored into the quoted commission rates. However, since investors trading via direct access choose the exchange they may be charged the exchange fees, which range between $0.001 and $0.004 per share depending on the exchange.