WASHINGTON. In the previous installment of our Investing 101 series, we explained that when opening a new brokerage account, a new investor generally must choose between a full service brokerage house or a discount brokerage house. Then, we focused on the full service house. But today’s investors can also choose to invest through a discount house. That’s today’s topic.
What’s a discount brokerage house?
Compared to full service houses, discount houses, or discount brokerage houses, are, as I once heard in a Cheech & Chong movie, “the same, only different.” Both varieties perform most of the same basic services. But, at least at their beginning, circa the 1970s, the original discount houses were very “bare bones.” For experienced investors, the main attraction of doing business with discount houses is that they offer deeply discounted sales commissions on securities trades compared to heftier commissions charged by large, full service houses. But in those ancient times, discount shops offered little else. And absolutely no research or advice.
Discount brokerage houses began to gain more attention when I was in the business in the late 1970s through the mid-1980s.
Investment tales from back in the day
More and more investors just loved those cheap commissions. In fact, that’s one of the reasons why I exited the business. I had an increasing number of fair-weather clients who’d regularly consult me for research suggestions. But then, they had to “think about it.” (That dreaded signal of consumer insincerity that anyone in commission sales comes to hate.) I later discovered that an increasing number of those customers would pick my brains, take my information and place their trades at a discount house.
If you worked primarily with retail clients as I did, you could easily see the handwriting on the wall.
Early on, discount houses offered fast trades and minimal service. No phone calls, no advice, no research. You just called an 800 number on your landline. A licensed broker picked up, and you placed your order. Research? Forget about it.
Discount brokers were hired as order takers. They were not permitted to give investment advice under any circumstances. You did that on your own dime. You read the Wall Street Journal every day. In addition, you checked out the weekly Value Line recommendations every week at the library. Or you pored over whatever expensive investment research newsletter your could afford. You were completely on your own. But those commissions were cheap.
PCs and the Internet: agents of change
This investment landscape gradually changed during the late 1980s and early 1990s and continues to change. One major change involved the increasing ubiquity of personal computers and the gradual birth of the online internet.
When I was in the full service part of the business, my most precious advantage was my green-screen Quotron machine. It gave me up-to-the-minute updates on the universe of stocks and related investment vehicles. The average retail customer couldn’t afford one of these. As a result, and without an internet, the only guy they could go to for trading was me. Or my competitor.
As the 1980s advanced, discount houses started offering more services, including at least limited research. Even more dramatically, as the internet matured, discount houses were among the first to allow do-it-yourself, real-time, on-line stock trading for their customers. Full service houses started lowering their sales commissions to compete. The competition continues to this day. (More on this in a moment.)
About those commissions
When I taught after-hours investment classes in the 1980s at a local community college, I explained to my students that, given the average full service commission rates in effect at that time, they’d need to get at least a one point gain in an average stock investment just to break even on the eventual trade.
An average retail investment in a given stock was preferably transacted in “round lots” at the time. (A round lot is 100 shares or a multiple of 100 shares.) In the 1980s, the average commission on a mid-priced common stock was $30-40 per per round lot. So $100 was close enough to serve as a good rule of thumb. In other words, you had to be convinced that a given stock was going to move more than 1 point over a reasonable period of time in order for your investment to make sense vs. the cost.
So you’re clear, commissions on a round trip trade – buy and sell – are charged on both the buy and the sell. So the hypothetical round trip above would actually end up costing you two times that per-trade estimate after you sold the stock. Roughly $60-70 per share. So $100 was a good, round-number estimate.
Discount houses, on the other hand, charged a fraction of that number. This, unsurprisingly turned out to be their greatest appeal. Breakeven on a trade was much lower. Assuming you knew what you were doing.
Today’s comparitive figures are considerably lower.
Full service vs. discount brokerage houses
Today, whether you choose a full service house vs. a discount house really depends on your personal situation. Full service houses still provide full service. This is particularly important for investors who want to build a serious portfolio, but don’t have the time or inclination to do the homework. If that’s your situation, and if you find a good personal broker, you’re in good shape.
With a discount house, you’re still largely on your own. You have to make up your own mind using whatever research resources may be available.
But discount houses have changed a lot from their bare-bones beginnings. The best known houses like Schwab, E*Trade and TD Ameritrade offer both outside and even some proprietary research resources for you to consult. In larger cities, they frequently offer informative investor seminars, portfolio management services and so forth. And even actual offices where you can talk to someone.
A more recent development: Inexpensive, “robo-advisor” directed managed accounts. More on this later, after we explore the wonderful world of stocks.
Commissions-wise, numerically speaking, the large discount houses continue to cut them to the bone. Now, even full service houses are experimenting with lower pricing models. For a more thorough discussion of typical commission rates, here’s a useful link.
Numbers and services may change again even as you read this column. So shop around.
Hopefully helpful hints.
- If you you want to invest in stocks and bonds but don’t always have the time to hawkeye your investments, a full service broker may be your best bet.
- If you prefer to do your own investing and research and, above all, have the time at your job or at home to work uninterrupted on your computer, then you’ll save a lot of money going with a discount brokerage house.
Since I work out of my house these days, and since I used to do this for a living, the latter choice is the way I roll. .
Once again, your choice of brokerage house and level of service is a personal choice. Just be sure you know what you’re doing.
Next: We begin our exploration of the wonderful world of stocks.
— Headline image: Stock and bond trades: Rolling your own at a discount house. (Public domain image via Pixabay.com)