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Investing 101: Choosing Between Discount Broker & Full Service Broker

The first step in managing your own portfolio is selecting a broker so that you are able to trade positions, whether online or over the phone. The main role of the broker is to be the medium by which you buy or sell stock. Stockbrokers make money by charging various fees such as brokerage commissions, margin interest and service charges. It is very important that the brokerage you choose be registered with the Financial Industry Regulatory Authority (FINRA) and the SEC in the US, or the IIROC in Canada.

Brokerage companies can be separated into two main categories: discount and full-service. Your choice will depend on your needs and the type of investor you are, as they both have their distinct advantages and disadvantages which will be describe below.

Full Service Brokerages

Full service brokers are more suitable investors that require more guidance and support than the average investor. These brokers will offer a full line of services including: access to research, recommendations and the ability to make investment decisions on your behalf. However, all this support does come at additional cost.

A full-service brokerage will more often than not, be more expensive than a discount brokerage for the obvious reasons mentioned above. They charge higher commissions and fees to pay for the surplus of services provided and usually require a substantial amount of initial capital invested ($50,000+).

More importantly, your account representative's intentions may not be completely aligned with your investment objectives. Despite the fancy titles and pampering, you must remember that these professionals are sales people at the end of the day and their salary is based on commission. Therefore, the more they get you to trade, the more money they end up making. That is the primary cause behind "churning" that some brokerages participate in, where there is constant buying and selling of securities for the sole purpose of generating commission fees.

These fees in the long run will take a large chunk out of your overall return which is a reason why a lot of investors opt for discount brokers.

Some of the top rated full service brokers are

American Canadian

Merrill Lynch TD Waterhouse

Wells Fargo Advisors Scotia Mcleod

Edward Jones Edward Jones Canada

full service brokers

Discount Brokers

Investors that have more experience under their belt and better equipped to make own investment decisions should choose a discount brokerage. These providers do not offer the glamour services or guidance, but a basic platform for completing your transactions. In times past, discount brokerages could be categorized as either an online broker or a conventional one. But nowadays that distinction has virtually disappeared.

As the name implies, a discount brokerage will be less expensive than a full-service brokerage since you will be doing your own research, without any advisors at your disposal. Since a discount brokerage does not offer the same guidance, they have no vested interest in pushing a certain stock or cross selling you. Finally, many of the more established discount brokers will provide you with some educational material and necessary research on their websites.

When choosing this platform, you must keep in mind that you'll be left to your own devices with no support system or safety net, that hidden fees (like the mailing of statements) may be attached to certain services and that the customer support most likely will not be on par with the full-service firms.

Some of the top rated discount brokers are InteractiveBrokers ,TradeMonster andTDAmeritrade in the US, Scotia Itrade, BMO Investerline and Questrade in Canada.

Discount brokers

Types of accounts

Brokerage firms offer investors many types of accounts, here are the three basic types:

  • Cash account: As the name implies, you deposit an amount of money with your account application and this amount will vary from broker to broker.
  • Margin account: A margin account will allow the investor, after approval, to borrow money against the stocks or cash that he has in his account, to buy more securities. Most margin trading limits for stocks is 50%, so if you want to trade $1000 on margin, you would need to have $500 in cash. Interest rates will vary from broker to broker.
  • Options account: An option account will offer you the capabilities of a margin account with added bonus of being able to trade options on stocks and indexes.

Before you make your final choice, it is important that your investment style and what you want to accomplish. After, choose the broker that will charge you the least for the amount of services and support that you will require. A practical and convenient solution would be to open a brokerage account in the bank with which you day-to-day transactions complimented by research from 3rd party sources. For example, if you do everyday banking with TD Bank, the most convenient broker would therefore be TD Waterhouse. This would allow for easy transfer of funds between accounts, possible lower fees/commissions, and collateral already in place for margins. Supplementing this account with 3rd party research platforms like the Last Financier will give you more control over your investment decisions, information sources and research costs. Choosing a broker isn't a life or death decision, but it will have a significant impact on your overall investing experience.

This article first appeared on GuruFocus.