A Guide to Online Brokers for Investing Newbies (and Beyond)

by Julie Rains on 3 January 2013 9 comments
Photo: Victor1558

Online brokers are known for cheap commissions on stock trades, along with low-cost account management services. These firms provide a place to start, grow, and maintain financial investments through regular brokerage accounts, retirement accounts, and more. Investment products available to fund these accounts may include stocks, ETFs (exchange-traded funds), and mutual funds.

Although online brokerage services were originally started as DIY alternatives to pricey traditional brokers (think Merrill Lynch in "Mad Men" days), they now offer a full range of services. Most have educational resources on investing along with tools for selecting and evaluating specific stocks. Many provide financial advisory and portfolio management services. (See also: 5 Killer Free Investment Tools)

Background

To understand and appreciate the services offered by online brokers, knowing the background of brokerage houses can be helpful.

In the 1980s and earlier, investors typically had few choices when purchasing publicly-traded stocks and mutual funds. They could:

  • Buy and sell stocks using a full-service brokerage firm, paying commissions that typically exceeded $100 per transaction
     
  • Invest in a specific company that offered a DRIP (dividend reinvestment plan) by purchasing shares on a monthly or quarterly basis
     
  • Purchase shares of mutual funds directly from the fund family, which involved paying sales and redemption charges on load funds while avoiding commissions on no-load funds

Trading fees at full-service firms were steep, as they covered sales commissions of stockbrokers. Ideally, the stockbroker recommended trades that were suitable for and benefited the growth of your investment portfolio based on proprietary market research of the brokerage firm.

But even if you didn’t need or want advice from the stockbroker, you still had to pay a sales commission. Discounted brokerage services were made possible when the SEC mandated negotiated rates in 1975, eliminating fixed commissions. In the 1990s, these discount brokers introduced web-based services so that customers could make online trades rather than giving orders to a phone representative.

Online brokers have continued to evolve. Product offerings now include options and foreign stocks. Just as significantly, many serve more than the DIY market through financial advisory and money management services.

Ways to Evaluate Brokers

There are many ways that you can evaluate and choose an online broker. The cost of a standard online stock trade, account minimums, and account maintenance fees are the features most often touted. (See downloadable spreadsheet: Basic Guide to Online Brokers, comparing various brokers.)

Those factors are relevant, but there are also additional elements to consider in selecting a broker (or brokers).

Stock and ETF Trading Costs

The most prominent measure of an online broker is the cost of an online stock and ETF trade. Typically, these are flat fees regardless of the number of shares bought or sold.

Note the standard fees for online trades (as of December 2012):

Some brokers trade certain ETFs commission-free. On the other hand, fees for trading penny stocks (generally defined as equities with share values of $2 or less) may be higher and include charges related to the number of shares in the transaction.

Also, if you need to make the trade via an automated phone line or with the assistance of a broker, then you’ll typically pay either a higher flat fee or an added service charge. These fees may run up to $44.99, cheaper than traditional brokers but not nearly as inexpensive as standard online rates. However, you should be able to engage a phone rep in walking you through the mechanics of a trade that you initiate and complete online without an extra charge.

Account Minimums

If you are just getting started in investing, the minimum amount to open an account is of particular importance. This number often varies on the type of account. A regular brokerage account generally has a higher minimum than a retirement account, such as a traditional, Roth, or SEP-IRA.

Minimums to open a regular account are:

  • Charles Schwab: $1,000
  • E*Trade: $500
  • Fidelity: $2,500
  • Merrill Edge: $0
  • Scottrade: $500
  • TD Ameritrade: $0
  • TradeKing: $0
  • T. Rowe Price: $2,500
  • Vanguard: $3,000
  • WellsTrade: $1,000

When talking with broker representatives, I learned that account minimums can be flexible. For example, a phone rep at Schwab said that the account minimums on its website are "suggested" rather than required. Similarly, a Fidelity rep told me that there is no minimum to open a brokerage account, but mutual funds generally have $2,500 minimums. E*Trade accounts can be opened for $0 and then funded over a period of two months. Some minimums can be waived if you opt to make automated monthly contributions.

Account Fees

Many online brokers boast the absence of annual maintenance fees. And, thankfully, the majority of firms do not charge to hold your account.

Still, it’s a good idea to ask about fees. These could include account opening fees, account closing fees, or quirky fees such as TradeKing’s inactivity charge or low-balance fees charged by Fidelity and T. Rowe Price. Some fees can be waived by meeting certain conditions that could include choosing paperless delivery of monthly statements or maintaining a certain dollar value of assets.

Mutual Funds

Online brokers vary greatly in their scope of mutual fund offerings and associated fees.

However, nearly all distinguish between no-transaction-fee (NTF) mutual funds and transaction-fee mutual funds. Put simply, you pay no fee for an NTF purchase or redemption but pay a flat fee for buying or selling transaction-fee funds. (Note that an NTF fund may or may not be a no-load fund. For example, some brokers charge no commission for load funds, presumably earning a sales commission from the fund company rather than charging the individual investor. Some charge a commission for no-load funds.)

A few brokers have designed mutual fund networks or programs allowing commission-free purchases and redemptions. These programs may contain proprietary funds (created and sold by the brokerage firm) and/or selected mutual funds from outside fund families. For example, you can purchase Fidelity funds for free at Fidelity but pay a $75 commission for non-Fidelity funds. Similarly, an investment in one of the funds associated with the Schwab OneSource Program is free; purchases outside of this program are $76.

In addition to the commissions and fees charged by brokers, a mutual fund company may have fees distinct from the purchase or sales transaction; discussion of these fees can be found in the fund prospectus. Further, many brokers charge an early redemption fee for funds sold within a designated time frame after a purchase (generally 90 days or less).

Some investors favor online brokerage services with historical roots as mutual fund companies. For example, Mike Piper, a CPA who writes about low-maintenance investing at the Oblivious Investor, likes Vanguard and Fidelity because of the breadth of mutual fund offerings available commission-free, particularly for tax-advantaged accounts such as Traditional IRAs, Roth IRAs, and SEP-IRAs.

Customer Service

Customer service is delivered through toll-free phone calls, live chats, email, secure messaging systems requiring account log-in, and face-to-face consultations at branch offices. The responsiveness, availability, and expertise of service representatives will depend on your choice of online broker.

Even if you expect to handle transactions exclusively online, you may occasionally need help in these areas:

  • Responses to general inquiries about fees, opening an account, etc.
  • Assistance with account-specific concerns relating to trades, account balances, etc.
  • Financial advice pertinent to your goals and risk tolerance.

General guidance is typically free, but more expert direction can cost you.

Investing Resources

Most online brokers offer investor education for DIY investors that is particularly useful for newbies. Some provide more sophisticated tools and expanded services to advanced investors and those with large investment portfolios.

The types of resources:

  • Market news, insights, and commentary
  • Education on products and types of investment accounts
  • Investment planning tools
  • Trading and analysis tools (including real-time, streaming quotes)
  • Financial planning services
  • Portfolio management services

Certain services are ideal for those who enjoy the value-consciousness of an online brokerage firm but are willing to pay for expert financial advice. This group of investors can tap the knowledge of a financial advisor for specific concerns, locate and fund a pre-fab investment portfolio that matches their risk tolerance, or enlist the services of a money manager.

Deals

Most brokers have deals for new or active customers. These generally include:

  • Cash bonuses for opening an account or adding to its balance
  • Free trades for referring a friend or maintaining a high account balance

Note that qualifying amounts for bonuses can be very high though the average investor can typically qualify for free trades.

How to Choose an Online Broker

When reviewing the price structures and services of online brokers, notice the strengths that are most closely aligned with your needs. Start with identifying your needs now and those you anticipate having in the future. Ask yourself questions like these:

  • What type of account do I want to open?
  • What types of investments do I prefer?
  • How much do I have to invest now?
  • What is my level of comfort with independent investing?
  • Would I like to have assistance in managing my money?

Also, determine if you have special needs. Your responses will guide your decision as you choose an online broker.

For example, if you are most interested in investing in mutual funds, then a firm with a wide variety of no-transaction fee funds is ideal.

If you hope to grow your account balances to a level that will qualify you for specialized services, then the firms with full-service features at a relatively low cost may be perfect for you.

If you want to invest in IPOs, Kiplinger mentions that Schwab, Fidelity, and TD Ameritrade can provide client access to initial public offerings.

If you want to open a Roth IRA for your child, Doug Nordman, a military veteran who writes about early retirement and financial independence, tells me that certain brokers will allow minors to have a Roth IRA while others don't provide such services.

If you have a variety of needs, you may want to open more than one account. Using this approach, you'll forgo some benefits associated with high-dollar balances but may be able to save on fees for certain types of investments and transactions. Whatever you decide, don't be afraid to ask for specialized services at no cost or a reduced fee.

What fees, account features, and services do you consider most important when evaluating an online broker?

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Guest's picture

Thanks, Julie!

The fund companies are beginning to pay more attention to minor IRA accounts, so it's worth checking one final time with those mentioned in my post.

Julie Rains's picture

Thanks for even thinking about minor accounts -- it wouldn't have occurred to me to pose that particular question. And, as you mention, broker services are constantly changing (plus some services, pricing, etc. are negotiable) so it is wise to speak directly to a representative before opening an account.

Guest's picture
Renee S

I actually had to just switch brokerage accounts because Scottrade did not have what I wanted--DRIP. I switched to Fidelity which was difficult because I really liked Scottrade. Fidelity, though, has been very good to me! I like their online chat option with a representative. They helped me with the process of transferring my accounts and they even reimbursed the $75 fee I was charged by Scottrade for transferring.

Julie Rains's picture

Thanks for sharing your experience. I don't know if everyone can anticipate all the services they might need or the types of investing they might want to do over an investing lifetime so sometimes you may need to switch (or open more than one account). Also, glad you were able to get the closing/transfer fee reimbursed -- many brokers will cover those costs for you.

Guest's picture

Great post. Thanks for the tips. I am already into stocks investment but I still learned a lot from your post. I am sure other newbies will learn from you as well.

Julie Rains's picture

Glad you liked the post. I also learned more when researching various brokerage firms -- mainly about various firms' strengths.

Guest's picture
Maxime

This is a wonderful guide to brokerage accounts.

I'd also like to add that investors should make sure to look beyond the name brands. Lightspeed, Interactive Brokers, and Just2Trade all charge less than $2.50 per trade, while still offering great service.

And if you're looking to transfer accounts, check out which brokers will cover ACAT fees. TradeKing, tradeMONSTER and OptionsHouse will all help to cover your fees.

Maxime
NerdWallet

Julie Rains's picture

Glad you liked the guide. The guidelines for evaluating a broker could certainly be applied to the ones you mentioned, like TradeKing and Just2Trade. Besides the pricing, some of the biggest differences among brokers tend to be research & education, number of mutual funds offered at no cost, and financial advisory services (including portfolio management programs). Also, some brokers tended to promote their options and foreign exchange trading but those may not be as relevant to new investors; so, re-evaluating brokers as your needs change (and as brokers change their offerings) is a good idea.

Guest's picture

Thanks Julie for detailed information to choose an online broker. I am a forex and stock broker but first time came through such step by step guidance regarding online brokers.