This year, trading online through a discount broker, rather than with a full-service broker, is increasingly the preferred option for many investors. But risks remain.
The main advantage of switching to a discount broker is lower commissions. And commission rates can be even cheaper if you trade stocks with your discount broker online, as opposed to placing orders over the telephone.
Several years ago we asked our website visitors whether they 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.
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Although lower commissions are a plus, there are several reasons to be cautious. 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 thing 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.
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.
Know the risks of online trading with a discount broker
Online trading with discount brokers may look like a fairly quick and convenient way to build wealth, but there are many hidden dangers that may not be evident at first.
The main risk comes from the fact that it all may seem deceptively easy. The lower costs and higher speeds of online trading can lead otherwise conservative investors to trade too frequently. That can lead you to sell your best picks when they are just getting started.
The apparent ease of online trading may even prompt conservative investors to take up short-term trading or day trading. That’s just another danger of trading stocks online—there’s a large random element in short-term stock-price fluctuations that you just can’t get away from.
This random element can be profitable for short periods. But you can’t reliably profit from it over the long term. In fact, most short-term traders wind up losing money. By the time their beginners’ luck fades, many are trading in dangerously large quantities.
Frequent trading can also lead you to buy lower-quality, thinly traded stocks. The danger arises from the fact that the bid and ask spreads of many of these investments can be so wide that the share price will have to go up significantly before you’ll even begin to make money on a sale.
You can make trades quickly in online trading, and that cuts your commission costs. However, for successful investors, this is a bonus, not the object of trading stocks.
No one will warn you about potentially costly mistakes
Before you switch to a discount broker, or “no-fee” broker, remember that doing so gives you unlimited opportunity to go wrong on your own. 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 website.
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.
In the long run, the best way to cut commissions is still the same now as it was 10 years ago: stick to high-quality investments and make 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 $18 or so to reinvest after paying capital-gains taxes and commissions.
It is far more important to focus on high-quality, well-established companies and how they fit in your portfolio for the long term. The longer you hold these stocks, the greater the chance that your profits will improve, as well. That’s something your discount broker won’t tell you.
If you have switched to trading with a discount broker online, was the prospect of cheaper commissions the main reason you did so? Or did you decide you simply didn’t need (or couldn’t trust) the advice of a full-service broker? Let us know what you think.
Note: This article was initially published in 2014 and is regularly updated.
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I wanted to save money and also thought I knew enough to invest/trade on my own. I lost money for awhile, learned what I was doing wrong and am now happy with using a discount broker. I don’t think the type of trading service you have matters as much as your trading style. If you are able to learn from your mistakes, not listen to ‘tips’ or your own ego, then you can be successful with either type of brokerage service.
We use discount broker because they do not have a hidden agenda. Full service brokers have to sell what their company is pushing not what is in our interest. We should take our cues from investors like Warren and Pat. Invest in value and hold!
I think these brokers charge these low commissions,because they want to make investors think that is the cost of a trade,when the spread is where the brokers make their money.The best thing about discount brokers is that you don’t have a salesmen(AKA stock broker) messing up your decisions with his opinions and convincing you to make unnecessary trades.
To your article today regarding switching to a discount broker. This was done due to distrust of the broker and his recommendations that kept on coming.
Early in my investing experience, I had three bad situations with full service brokers. The first was when a broker told me to sell my shares in a company that I had held for quite a while & then the company announced a takeover a few days later at a nice premium. When I questioned the broker about this, he said he didn’t know anything about it. Something didn’t seem right, so I switched to another broker. He recommended a company that I had heard of, so I bought some shares & a few weeks later the broker recommended that I should sell them after the share price had dropped substantially. Who made the profit? Then I went to a third broker, who I knew from my neighbourhood, & I made some good profits because of my own research. He then started calling me to ask what shares I was considering buying told some of his other clients to buy them. He got the commission, but I didn’t. I switched to a discount brokerage about 20 years ago. I’ve had some losses, but my gains far outweigh them. I stick mainly to stocks because I think mutual funds, in general, suck. Their fees are far too high & too often their performance is poor. I have lost confidence in full service brokers & financial advisors, who get their commissions for what? My wife has a financial advisor who we both like & trust, but most of his recommendations have not come close to what I’ve achieved with my own research, which includes a couple of your newsletters.
We used a full service broker for five years and he managed to lose money for us every year. $30,000 in total. I have followed your advice Pat, from time immemorial and decided that that five year experiment was both expensive and untrustworthy. Now we use a discount broker – the commissions are less and the mistakes are ours. So far this year we are showing a gain of 7% or better as well as a cash accummulation of dividends of at least 5%.
I have lost more money than gains thru 3 different brokerage companies: I have made far more money using a discount broker. Yes my $ 10 trading fee entices me to trade often – however I do monitor this. Good news is that I don’t have to worry about buying or selling odd lots. Brokers were alwayss encouraging me to buy or sell more shares. PLUS They almost all claim, they hold these recommended stocks in their own accounts; never sell them; and incredibly only hold about 10-20 stocks in their own accounts. #’s dont add up.
My full service broker had been trying to get me to sell TRP for years even though its price climbed slowly but steadily upwards along with its dividend. He talked me into buying Sunbeam several years ago and encouraged me to hang on even though it went to zero. With advise like that I decided to handle things myself online and have done quite well since.
One nice advantage of having a discount broker is avoiding the very often delays trying to get through on the phone and if successful then you get the feeling of being rushed by your broker .
I for one love the independence of doing things for myself and simply love the option of trading for myself using my discount broker account.
I rely on investment online site such as yours to help me make my own decisions
I use a discount broker for two reasons:-
1. The price is right.
2. After 50 plus years of investing with brokers and money managers of all types and persuasions, as well as exhorbitant fee structures, I have yet to find one who can manage my money as well as I can.
I do the same after bad experience with a broker and some funds, I would like to compare notes with you as to your investments
Thanks for your comment.
After a family member who managed our money got out of the business, we had some very bad experiences with three different full service brokers. Reading and following people like Pat and rebuilding our portfolios, I think I have a good handle on much of what I need to know. No body cares about your money like you do. I am very nervous to hand over our portfolios to anyone again…
I switched to a discount broker initially because my broker kept phoning me with buy and sell suggestions when I was focussing on my own work as an engineer.
Since switching I have enjoyed learning how to invest using the advice taken from newsletters including yours. An added bonus has been developing more interest in general world events and trying to anticipate the effects on my stocks. The lessons learned of buying sound dividend paying stocks so far have paid off well, however I also have suffered the nerveracking temporary loss of half of my account on three occasions. My daughter has also benifitted with her own accounts and my four year old granddaughter already has hers.
I used a discount broker for about 15 years, switched to a financial adviser in the hope of doing better and making fewer mistakes. I found there was was a lot of sales effort to sell me insurance based products and mutual funds with deferred charges. Annually he recommended selling 10% of the funds which could be sold without a charge of course with a recommendation to buy another mutual fund with a deferred charge. This seemed like an income generator for him and little benefit to me.
His advice for stock purchases was no better than my own and certainly no better than the recommendation from the Successful Investor. After 3 years we had a mutual parting of ways, (he new he was not adding value for me).
I switched back to the discount broker and will not entertain another adviser.
I have a diversified portfolio along the lines of Pat’s recommendations with a focus on dividend bearing stocks.
My biggest mistakes were those stocks that were supposed high growth with no dividend. Fortunately these were always small positions.
I see little if any value in an adviser.
It is now four and one half years since I commented. I am still using a discount broker and am still following Pat’s advice. Our cash account is showing a ROI of 68.84%, our RIF accounts are showing ROIs of 86.87% and 89.39%. Each year we have withdrawn about $7000 from the cash account accumulated dividends and the minimum amount allowed from our RIFs. Yes, we have sold stocks, but not very many, to crystallize the losses which will be put against capital gains we incur when we sell rental property. Our investment record of 50 years has never been so good, and the blame lies squarely with Pat McKeough and his fantastic insight of the stock market.
I switched to a discount broker, $7 a trade, 6 months ago and never have been happier. My full service broker charged $140 a trade, no matter how large or small. Now I can trade smaller amounts and more frequently and still save money. I was making most of my investments without following his advice anyway and whenever I did it seemed to lead to losses. He was a master salesman and knew how tro manipulate me his client. When he figured out what my preferences were he tried to exploit me to his advantage and I got into a couple of stocks that I did not know anything about. After a very serious disaster I was fed up and started to look for alternatives. I was amazed to see how easy it was first to switch, I stayed with the same bank and simply switched between accounts. Could not have been easier and didn’t say a word to my “full service” broker. Have not heard from him since. I follow my aggressive investments in a manner which is different from that of the full service analysts. The presidents of my two favourites speak to me using my first name, and I haven’t missed an AGM or a quarterly CC in 9 years and have multiple bangers on my hands. The “full service” guy wanted me out of them. Do your own due diligence and use your own skills and knowledge to back up your moves and believe in yourself.
I would have to agree with all my fellow investors’ comments comparing the cost effectiveness and transparency of charges of discount brokerages (is this simply a personal online trading account with a Big Bank?) versus brokers/financial advisers.
While I have been fortunate with my broker who sold me two mutual fund policies who does not encourage any turnover of the funds, he has however benefited in the sale of very-long term policies of 25 years. I believe this is very rare or not recommended (I’d like to know some reasons why this may be so?).
I’ve used a spreadsheet to calculate the number of units deducted over the life of the policy and it is a substantial amount assuming even no appreciation in the unit price. The policies are currently in the red which does benefit dollar cost averaging providing the funds do rise with the markets.
Using TSI’s advice, my own portfolio of stocks is returning a 12-month rolling average over $1,000 nett, and growing.
I would recommend to anyone to invest in TSI’s newsletter(s), do your homework for two years (eg study your market) and manage your own investments. Thanks Pat, TSI and fellow investors.
If you have a full service broker who gives you good, reliable advice, then keep him or her: they are probably worth the money you pay them. But, it’s a BIG “IF”. Many of them do not, and if they don’t fire them….and my own best advice is learn to do it yourself, but like the article says, stay away from frequent trades, higher risk and stay diversified in common equities, prefered equities and a few debentures in quality companies based on information from TSI or another reputable source with no conflict of interest. The rest is dross–especially if they have an incentive to get you to buy or sell their products.
I have used a discount broker for over 8 years and have simply followed Pat’s advice. I may be a bit lucky but I have averaged over 10 percent during this period. I don’t see the value of paying a broker or a firm to manage my money. Even a 1% annual fee would mean I would pay about $500 per month for someone to manage my investments. If no one can consistently beat the averages over time, then what is the value of paying for this service?
julien schryer I have used numerous brokers over the years and have done quiet well since using discount brokers
I have been trading through a discount broker for the past 25 years. When I dealt with full line brokers, I usually had poor results. Which is confirmed by statistics. Year after year, 80% of portfolio managers do worse than their indices of reference. Unfortunately, a number of stock brokers that I know are big talkers; they keep repeating things that we already know or read about on the internet.
I would like to underline what Tom has said above: use Pat’s recommendations and trade through a discount broker. You’ll do just fine.
Most full fee brokers now charge a fixed percent on your portfolio regardless of performance rather than high fees per trade. The logic was to remove the churn and burn incentive that had given the brokerage business a bad name. However, most investors do not check whether they are getting value for what is now a quarterly tax on your portfolio. This is also somewhat masked by charts showing long term performance of your total portfolio some of which was bought at far lower market levels. To me, a simple value test is to compare the investments made in a particular period against the fees paid in that period. You may be rudely surprised that your investment returns are outweighed by the fees – furthermore, unlike the days of just paying for a trade, your quarterly fee continues to add tax to both that incremental investment and all other aspects of your portfolio. If the market is moving upwards, your broker tends to brag about his fees are outweighed by the recommended investment performance but in a downward market, he continues to get fees (although slightly smaller) but there is seldom any talk of his performance or incremental value add during that time. It’s like low fee ETFs vs. High fee Mutual funds – both ride the market waves but one taxes you less for tying up your money and over time lower costs usually win. There is an old adage – how do you make a small fortune? Give your broker a large one!
I had a bad experience with a full service broker right out of the gate, put me in a not too bad stock which was doing not bad then convinced me to sell and buy a different stock that went belly up and lost all my investment, thank God I learned early, then on to mutual funds , some good, some bad, but fees were a killer, decided to take my money out, bought my own stocks, have had some ups and downs, but the longer I hold the better it gets when I nee, like d some money I will keep the stocks and take the dividends. Like having a herd of cows , sell the calves and keep the cows. I have also set up accounts for my kids for their old age, mostly tax free savings money, so no tax, it’s a win win for long term
To all above comments about full service brokers –Ditto !! They exist to take your money away by trading frequently. Two other comments –Many of TSI`s recommendations and advice seem quite good — For example to hold at least two Canadian bank stocks and stay with them and to concentrate on dividend paying stocks. Back in 2009 I started with TSI and with a few shares in BCE which I then doubled in number and I added a bit of CAE ( at under $ 7.00 ) and stuck with it but I should have bought more obviously. I also bought Teck at about $ 4.00 and watched it go to $62.00 TSI kept saying “BUY” so I held on and got sick as it kept falling and falling and TSI kept saying “BUY” Finally I did sell at a very small profit before it went back to almost $ 4.00 again. TSI`s HUGE failure is not saying SELL when the stock stops going up and starts heading down. TSI is NOT to be relied upon for its sell signal — devise your own. I made some profits on Sprott which TSI does not cover and I made a triple on NFI which TSI did not cover but I sold too soon in both cases. TSI needs to do MUCH better on the SELL side. Some of their BUY advice is decent but we need to check other sources as well. .
Thanks for your feedback.
A Second Comment : TSI does not like mutual funds and a lot of BNN`s commentators also do not BUT that is because the mutual funds are competition. They also compare ETFs with mutual funds –two very different animals. The mutual funds TSI etc. compare are usually those provided by banks` advisors and in that case the comparison could be apt. However a bank advisor cannot use “fee based” mutual funds which after tax can be comparable to or even better than ETFs . A good personal advisor could easily outline the serious differences between contributing to or withdrawing from ETFs versus mutual funds and other differences. Do not let biased advice confuse you about mutual funds handled by a good morals-focussed private fee-based advisor not in a bank . Do not compare apples to oranges !!
Thanks for your feedback.
Full service brokers are pathetic . Their only intention is to earn profit for themselves and not for you. The Wolf of Wall Street (https://en.wikipedia.org/wiki/The_Wolf_of_Wall_Street) is the perfect example of this . And to be honest you cannot make profit , identify a multibagger unless you have made losses (which is not substantial which u cannot cover ). Trading like any other profession requires time , effort and perseverance . One has to learn and understand the market before u can get a hefty profit . Here discount brokers come into play , they don’t tell u to buy or sell any stock and u are on your own because at the end of the day full service brokers takes their commision and will not say anything for ur losses even though they are responsible for that.
Thanks for your comments and thoughts.
Years ago I used Conner Clark . They were totally useless. Charged for handling the account and for each trade. After 4 years had enough. I did better handling my own money and it did not cost me an arm and a leg. Have been following Pat’s advice ever since THANKS DON