This weekend, I had a long conversation with someone who had — like many — never opened a brokerage account with an online discount broker.
Her trading needs were quite simple, and in the end, we decided the best thing for her to do is open an account with Vanguard and do the index fund investor route. Once she gets her feet wet buying a few index funds (like the S&P 500 or Russell 2000), she might try something a little more risky like buying individual stocks or sector based ETFs.
Most people know that I’m an active trader, but what surprises them the most is when they ask me for hot stock tip, I generally tell them to buy a Vanguard index fund (how very Yin & Yang of me right?). Since the majority of people are not willing to do the continual research on the stocks they own, selecting the passive investor route is the safer play for 99% of the people I know who want to invest.
That said, if you still want to try your hand at investing in the market and you’re searching for an online discount broker, here are a few questions you should ask of yourself and the features you will require when choosing from a constantly growing number of online brokers.
Just remember that each online broker has it’s good points, but they can also have a few negatives.
Introductory Questions When Choosing an Online Broker
- Do you really need to open a brokerage account? Most people are unaware that they don’t even need a brokerage account to buy a simple index fund or mutual fund. Just click over to Vanguard, Fidelity or Charles Schwab and you can invest commission free once you setup an account. Why pay $5 to $20 per transaction when you can buy index funds for free (minus the small management fees of course)?
- How much will you pay in commissions? Each time you make a trade, you will pay your broker a small commission to execute that trade. Trade executions will eat into your (potential) profits if you are an active trader, so shop around and find the best deals possible that fits your trading/investing style.
- What deals are being offered among the online discount brokers? Now that so many online discount brokers exist, they are forced to fight for your business. Shop around for brokers willing to give special deals like 10 free trades each month or a free finance magazine subscription.
- What is their customer service like? One of the easiest ways to upset a customer and lose their business is to have lax customer service. If they can’t answer your questions efficiently and promptly, find someone that will. Period.
- Can I actually speak to a broker over the phone if I don’t know what I’m doing? Whether you’re a noob or an experienced investor, sometimes people just want to hear a knowledgeable person’s opinion before making a new investment. The human touch still matters to some people, especially if they’re new to investing on their own.
- What type of investment research do they provide? Most brokers will claim to have vast quantities of independent research available on their site, but make sure to check it out beforehand so that their claim is legit, their research is up to date, and contains information you would be willing to use before making an investment.
- How long does it take to transfer money from my bank account? One of my biggest pet peeves is the time it takes for my money to show up in my account. Normally, 3 days is the general amount of time for a free ACH transfer between your bank and broker, but it’s worth asking if you’re the impatient type.
- Do they have a social network/forum to discuss your investments. One of the best ways to solve a problem, in my opinion, is by crowdsourcing. Most online brokers maintain an investor forum filled with helpful members, and if you’re the inquisitive type, asking a few dozen investors for advice definitely beats asking a single customer service rep.
- What is the account minimum balance? No reason to select a broker that requires a minimum account balance of $2000 when you only have $200 to invest. Some brokers allow you to build up your account balance steadily over time instead of all at once.
- Is your broker the best online broker? MSN Personal Finance, Kiplingers, and many other personal finance powerhouses do an annual review of the major online brokers. It never hurts to have someone backing up your own personal research.
Basic Trading Questions For Choosing an Online Broker
- Will you pay an inactivity fee? If you’re a traditional buy & hold investor, make sure your broker does not charge you fees if you let your brokerage account sit idle for 30 days or more.
- How dependable is their website? This is a tricky question and almost certainly will not be disclosed in their FAQs, but it’s something you should ask if you plan on being an active trader. Nothing worse than holding a 2x leveraged ETF and the site crashes 10 minutes before the market closes.
- Can you create an automatic dividend reinvestment plan? When companies pay dividends, most people tend to use that money to buy more of that company’s stock automatically. This allows you to defer paying taxes on the dividend payments until you sell the stock in the future.
- Can you earn interest on cash that is not invested? Sometimes the hardest trade to make is to make no trade at all. So if you decided to stay on the sidelines while the stock market was going up and down 750 points (or more) each day, it might benefit you to earn 1-3% APY on your cash while you wait for the right time to buy.
- Can you buy mutual funds or index funds? Some people may find it easier to hold mutual funds or index funds in a regular brokerage account rather than setting up an individual account with the investment management company. You will pay extra in broker commisions, but occasionally, some investors prefer it this way (personally I think it’s a waste of money).
Advanced Trading Questions For Choosing an Online Broker
- Can you trade derivatives like options, futures, or Forex? If you don’t know what these are, then chances are you shouldn’t worry about this question. If your goal is just to buy a few shares of Exxon Mobil or Proctor & Gamble once a year, then trading derivatives or Forex is the last thing you need to do.
- Do they offer real time quotes and professional trading software? Traders will tell you that having real time data is an absolute must have if you expect to make money in the market. Without them, you’re essentially making bets on a horse race that took place yesterday and other traders will profit from your lack of real time data.
- What do you charge to trade on margin? Occasionally, some people find it necessary to borrow money from their broker to buy additional stocks. I consider this extremely risky, but if you’re the riverboat gambler type, it is a question worth asking your broker.
- Do they offer trailing stops? Trailing stops can be a traders best friend because they allow him to automatically sell the stock if it falls from a previous high. For example, if you bought a stock a $100 stock and it quickly moves to $120, you will want to protect your profits. Set a trailing stop of $5 and if the stock falls to $115, you’ve guaranteed a minimum return of $15/share while still owning the stock.
- Are you paying the lowest possible price for your trade executions? Some brokers may not have the technology to guarantee the best price of execution. If you want to squeeze every penny out of a trade because you know it’s a short term trade and not a 5+ year investment, it will pay you in the long run to checkout their execution guarantees.
If you have additional suggestions, I encourage you to leave your comments below.