How switching to a discount stock broker can cost you money

In a recent TSI Network poll, we asked site visitors whether if trust the advice they get from their stock broker. Aside from a yes or no option, we gave visitors a third choice: “I trade online through a discount broker.” Seventy-five percent of the poll’s respondents selected this answer.

You can see the full results of this poll, and a full archive of previous polls, on TSI Network. Just click the “Poll Archive” button below the main banner on the site’s home page.

Discounters’ lower commissions are a plus — but use caution

The main advantage of switching to a discount stock broker is lower commissions. Commission rates can be even cheaper if you trade stocks with your discount stock broker online, as opposed to placing orders over the telephone.

However, low commission rates sometimes lead investors to trade a great deal. They may assume they can’t lose because they can sell at the first sign of trouble. Being quick to sell can cut your losses, of course, but that’s not the same as making money. And, if you stumble onto an investment that has a huge rise ahead of it, you may wind up selling just before the move begins.

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On the other hand, a good stock broker or financial advisor (one who is experienced, knowledgeable, and oriented toward the long term) is worth the higher commissions that you are likely to pay. For instance, suppose your full-service stock broker charges an average commission of 2%, and you replace one-third of your portfolio every year (both figures are on the high side). In this case, you’d pay 1.34% of your portfolio’s value each year in commissions. That’s less than the 2% to 3% management fee on a typical mutual fund.

A discount stock broker won’t help you avoid costly mistakes

Before you switch to a discount stock broker, remember that doing so gives you unlimited opportunity to go wrong on your own. That’s because the clerk who takes your order won’t warn you if they see you’re about to do something you’ll regret, even if they know this to be the case. As well, you’ll receive no guidance or investment advice while entering trades on a discount broker’s web site.

So before you switch, put yourself through a brutal self-assessment. Are you able to single out a selection of investments that’s right for you, keeping investment quality and diversification in mind? If not, you may be better off with a full-service stock broker, provided you can find one who values your business and puts your needs first.

Making fewer trades is the best way to cut commission costs

In the long run, the best way to cut commissions is by sticking to high-quality investments and making fewer transactions. This also improves your tax deferral.

For instance, suppose you buy an investment at $10 and it goes to $20. As long as you hold on, the entire $20 keeps on producing dividends and capital gains for you. If you sell, you’ll have only $16 or so to reinvest after paying capital-gains taxes and commissions.

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