Stock Brokers Discount vs. Full Service

¶ … right or wrong answer when it comes to evaluating discount vs. full-price stockbrokers. What is right for one individual is based on his or her needs, and the context of the situation. In general, though, the discount brokers are probably a better value when considering a number of variables, including: free stock information provided on the World Wide Web, capital gains taxes, and stock brokers' motivations (Investitor website).

In order to understand why the discount brokerage firms are "generally" better, one has to understand the difference between the two. Discount brokerage houses are essentially "order takers." You tell them what trades you want to make, and they execute them for a very small commission (usually somewhere around $5-$7 dollars a trade) (FoolU website).

In many cases, signing up for one of the online discount brokerages will earn individual free trades, as will large-scale trading. The reason why these brokerage houses charge so little per trade is that they simply "execute" the trade, and do not actively advise the investor on the right stocks to pick.

When choosing a brokerage house, this is the primary issue one has to rationalize -- do they want a stockbroker's advice, or can they make sound investments on their own? One of the main reasons why the discount brokers are considered better is because there is so much free information on the stock market nowadays. One can turn on the early morning TV, and get the same expert advice from MSNBC that they would from a professional stockbroker. Also, many of these online discount brokers offer the same advice on their website.

These brokers will usually have professional analysts on their staff, and they can reach a broad audience, and cater to the needs of different investors. For this reason, it is usually more frugal for an investor to read and rationalize the free market information, and subsequently invest through a discount broker.

There are, however, drawbacks to the online brokerage houses. For one, they run their business through a server, and servers are prone to break down (FoolU website). It is not a likely scenario, but one might find him or herself in desperate need of trading or buying when their brokerage server is down. Another downside to the websites is that human error comes into play. Instead of telling an individual what you want, you are typing your request online, and a small mistake could lead to one purchasing a lot more, or a lot less of what they originally intended.

We have explored the pros and cons of the discount brokerage houses, and now it is time to do the same with the established "stock brokers." Investing through them was the predominant way of executing trades before the Internet revolution. They were essentially one's only gateway to Wall Street. As previously mentioned, things have changed dramatically with the new technologies available. The professional stockbrokers have found themselves losing lots of business, but there is still an advantage to using them.

Stockbrokers, like the Wall Street analysts on television, are very informed about the markets. They can custom fit one's investment according to their goals (short-term growth, long-term growth, dividends, ect.). Stockbrokers also serve as a "human outlet" for customers. Customers worried about their investments, or who have questions, can always call their broker for instant advice.

There are downsides besides from the obvious cost that should be noted, primarily dealing with the brokers' motivations. Brokers are paid when trades are executed. For this reason, it is in their best interest to trade constantly. An excerpt from the website FoolU.com puts it succinctly, "Brokers are salespeople: They make their money only when you buy or sell. Because of that, they may try to get you to trade to frequently to make commissions for themselves -- generating "churn," which means you lose money." Because a broker has control of an individual's stocks, and because that individual has trust in the broker, it is very easy to trade unnecessarily in order to inflate commissions.

Another downside to constant trading is that it results in capital gains taxes. When profits are made through the sale of stocks (among other things), the government taxes these profits (Lewis). If stocks are held for longer periods of time, the tax is not nearly as high, but if they are bought and sold quickly, the capital gains tax is at its highest (Lewis).

As previously mentioned, both types of brokers basically cater to different people. The discount brokers probably cater to a much wider variety of people. For beginners with limited funds, especially, the discount brokerage houses are the smarter place to turn. If someone is investing only minimally, then the steep $100 or $150 commissions are definitely not worthwhile. Instead, it is probably in their best interest to do their own outside research, and opt for the cheap $5 or so trades.