Investing - Part IX

Choosing your broker

OK, it's been a few days since we last had an entry in the Investing Tips series that I've been running. This is the ninth part of my four part series. Potentially, your choice of broker may have one of greatest effects on the overall performance of your portfolio.

So where to start?

Well first, how comfortable are you with making your own decisions and living with the consequences? Believe it or not, but when it comes to investing, most people are not able to live with the consequences. Next, how much time do you have to devote to your investing? Third, how much knowledge do you have, and more importantly, how much are willing to invest in learning about investing?

Why are these questions important?

Well, there are really just two types of brokers: full-commission and discount brokers. Oh, they'll both try to fool you into thinking that they fall into some mystery category that is neither full-commish nor discount, but reality is that they will be one or the other. Finding a quality full-commission broker is like finding a gold nugget. Finding a quality discount broker is like hitting the Comstock Lode.

That's not to say that full commission brokers are necessarily better than discount brokers. It's just that full commission brokers tend to take your account more seriously as you are their client, not the firm's. Discount brokers tend to look at you more as a number, and everything that they are measured on is numbers. The company will view it as more important to talk with 100 clients in a day than to have 10 good conversations. That small difference in perception goes a long way towards defining the client/broker relationship. Both sets of brokers will have similar bases of knowledge. How much of gets imparted to you, the client, is the major difference.

So let's go back and look at your answers to the questions in light of the differences in the types of brokers.

The questions really answer three important questions: how much independent are you (as an investor), your time constraints, and your knowledge. The first question will also be greatly influenced by your previous investing experience.

It generally works out that if you're inexperienced, don't have much investing book knowledge, and are looking for someone to hold your hand, a full commission broker will be your choice. He's going to be much more willing to take the time to time and effort needed to explain what he's doing and why it's in your best interest (this last point is key, if he's not willing to explain any recommendation in terms of your interest then you need to reconsider using that broker). He is also going to spend much more time helping to find just the right investment choice for you. You'll pay a bit more (sometimes quite a bit so), but in return you'll receive individualized service and commitment.

On the other hand, if you've invested before, you've got some knowledge and some time on your hands, you can do very well with one of the discount brokers. Most discount firms will provide you with most of the needed tools, like research reports and market updates, to get you pointed in the right direction and then they watch as you go off and do your thing. Theoretically they will watch over your account to make sure that you're not destroying yourself. In practice, you can do pretty much anything without someone stepping in to question or guide you. It's only when the firm is at risk that they start to care.

So if you need lots of help, you'll want to go the full commission route. If you want to be left alone, you'll want to go the discount route. But what if you fall somewhere in between?

This is where it's going to get a bit trickier. You'll have to weigh what's most important to you. If you have experience and knowledge, try talking to a full commission broker and see if he'll discount his rates some if you do most of the work. That tact might be successful, it might not. On the other hand, if you have some time and a willingness to learn, but not much experience, a discount broker with branch offices might be the best way to go.

But what if you make the wrong choice? Or what if your situation changes?

Don't be afraid to switch brokers or your type of broker. Most firms do charge Transfer of Account or TOA fees when you take an account out of their firm. The fees normally run between $50 to $100 per account. Weigh that one time cost against the expected benefit of transferring. Say you've learned a bit about picking stocks and you're looking at switching from a full commission broker to a discount firm. The full commission firm has a TOA fee of $100, but you will save $75 per trade at the discount firm. Pure economics says that at two trades, you're already more profitable. Just don't forget to consider the value of the advice the full commission broker gives you. That might be worth another $1000 or more per year (it's all subjective, though. The question is how is his advice worth to you).

By the same token, if you're at a discount firm and you're losing your shirt on poor trades, switching to a full commission broker might be just what you need. His higher cost per trade, and the discount firm's TOA fee, may be more than offset by a reduced number of trades and more profitable trades when they are made.

But more than anything else, the most important thing when picking your broker is: how do you feel about them? The cheapest discount firm in the world will be a poor choice if you can't feel comfortable with their skills or knowledge. At the same time, the absolute top performing full commission broker will be a poor choice if the two of you can't properly communicate.

Before committing to a broker, talk to them. Ask them about favored strategies. Find out what the broker likes because it will influence his recommendations to you. If you're looking at a discount firm, call them at different times of the day. See what the typical hold time is like. Request samples of their research tools. Look around their website; see if it seems intuitive to you.

With either type of firm, don't be afraid to ask questions. Don't be afraid to put them on the spot. And if they don't make your cut, move on to someone else.

Choosing your broker will probably be the single most important decision that you'll make in investing. If it takes some time, that's ok. If you're not absolutely comfortable once the decision is made, don't be afraid to change. You are the boss of the relationship. Don't ever, ever forget it.