A broker is an intermediary between an investor and a securities exchange—the marketplace where financial assets are bought and sold. Because securities exchanges only accept orders from individuals or firms who are members of that exchange, you need a broker to trade for you—that is, to execute buy and sell orders. Brokers provide that service and are compensated either through commissions, fees, or payment by the exchange itself.
A broker may just be an order taker, executing the trades that you, the client, want to make. But nowadays, many brokers style themselves as “financial advisors” or “financial representatives” and do much more. As well as executing client orders, brokers may provide investors with research, investment planning and recommendations, and market intelligence.
Costs and Fees
Trade execution fees are important, but there are other brokerage fees to consider. Knowing the fees and additional charges that might apply to you is essential to making the most of your investment dollar. Here are some costs to consider:
- Minimums: Most brokers require a minimum balance for setting up an account. Online brokers typically have the lowest minimums, ranging from £500 to £1,000.
- Margin accounts: A new investor might not want to open a margin account right away, but it’s something to think about for the future. Margin accounts usually have higher minimum balance requirements than standard brokerage accounts. You also need to check the interest rate your broker charges when you trade on margin.
- Withdrawal fees: Some brokers charge a fee to make a withdrawal or won’t permit a withdrawal if it drops your balance below the minimum. On the other hand, some allow you to write checks against your account, although they typically require a high minimum balance. Make sure that you understand the rules involved in removing money from an account.
Fee Structures, Pricing, and the Fine Print
A common fee structure for a broker is a per-trade commission. This can range from almost nothing to more than £100 per trade depending on how it is placed (i.e., online or with a human broker), the size of the order, and how liquid or accessible the security in question is.
Some brokers have complex fee structures that make it harder to figure out what you’ll be paying. This is particularly common among broker-resellers who may use some aspect of a fee structure as a selling point to entice clients.
If a broker seems to have an unusual fee structure, it’s all the more important to make sure that it’s legitimate, suits your best interests, and complements your investing style.
Read the fine print in the account agreement and fee summaries if the rates seem too good to be true. Additional fees may be hidden there. These may include custodial fees as well as fees for wiring or withdrawing funds, closing accounts, transferring assets, margin fees, and so on.
Zero-commission trading
Today, many online brokers offer zero-commission trades in most listed stocks and exchange-traded funds (ETFs). This has dramatically brought down the cost of investing and trading for most individuals. How do these brokerages earn money then? Primarily through a process called “payment for order flow.” This involves routing customer trades directly to specialized trading firms known as market makers who literally pay the broker for the opportunity to be on the other side of your trade.
Investment Styles
Your choice of broker should be influenced by your investment style. Are you a trader or a buy-and-hold investor? Traders don’t hold onto stocks for a long time. They’re interested in quick gains greater than the market average based on short-term price volatility, and they may make many trade executions over a short period.
If you envision yourself as a trader, you’ll want to look for a broker with very low execution fees, or trading fees could take a big bite out of your returns. Also, don’t forget that active trading takes experience, and the combination of an inexperienced investor and frequent trading often results in negative returns.
A buy-and-hold investor, often called a passive investor, holds stocks for the long term. Buy-and-hold investors are content to let the value of their investments appreciate over longer periods of time. Many investors will find that their investing style falls somewhere between the active trader and the buy-and-hold investor, in which case other factors will become important in choosing the most appropriate broker.
Vet Your Broker
There are certain criteria every broker should meet. The broker, or the firm they’re affiliated with, should be a registered investment advisor (RIA). This means they are on record with and under the regulation of the SEC. The individual broker should be registered with the relevant regulatory body in the country in which you are based.
To buy and sell securities, a broker has to have passed specific qualifying examinations and received a license from your state securities regulator before they can do business with you.
Questions to Ask Your Broker
Aside from specific discussions about your goals, appetite for risk, and individual investments, ask your broker these questions before you get started:
- How are you compensated? Fees, commissions, or a combination of the two?
- What other charges do you or your firm have—transaction fees, account maintenance fees, etc.?
- Are you or your firm associated with any of the companies whose investment products you might recommend?
- Will I have access to my account online?
- How often will I receive statements?