The first order of business will be to find a good discount online broker. The good news is that a few of the big name brokers have lowered their fees or commissions recently, making them more competitive, and enlarging the pool of potential brokers. The bad news is that it is a cumbersome process to wade through all the detail of a broker's website to discover if they have hidden fees or surcharges. I have created a comparison chart called Best Online Broker for Small Investors and Penny stocks, which you can download or see below. This is not a comprehensive list of all brokers. Any company with a commission of greater than $10/trade was eliminated.
In the spirit of Buffett, who is said to look at the risk of an investment first, I want to mention, briefly, the notion of capital risk because a brokerage companies goes bankrupt or pulls a Madoff. We all know that in a traditional bank account the Federal Deposit Insurance Corporation (FDIC) insures our accounts up to $250,000 per depositor, per bank. This is not a permanent state of affairs, and is set to reset to $100,000 per depositor per bank in 2014. As the FDIC says on their website, the "FDIC insurance is backed by the full faith and credit of the United States government. Since the FDIC began operation in 1934, no depositor has ever lost a penny of FDIC-insured deposits." Of course, those in Nassim Taleb camp might argue, the FDIC does not make bank deposits risk free, but the guarantee does minimize the risk. The situation with securities is not quite as clear cut.
For stocks, the Securities Investor Protection Corporation (OTCPK:SIPC) is in charge. They have a brochure which you can download called SIPC English 2009. I suggest you read this or go to their website to truly understand what your capital risk is with regard to a broker failing. The high school student version of it is this: the SIPC doesn't insure an investor against loss. This should be self evident. If you are investing in the stock market you know that you could lose your money, that you have an expectation of risk. The SIPC doesn't help you avoid the risk. If your stocks decline in value, you will not get a check from the SIPC. But here is what the SIPC does say, "...(the) SIPC replaces missing stocks and other securities where it is possible to do so ... even when the investments have increased in value.
SIPC does not cover individuals who are sold worthless stocks and other securities. SIPC helps individuals whose money, stocks and other securities are stolen by a broker or put at risk when a brokerage fails for other reasons." The SIPC guarantees up to $500,000 per customer, including $100,000 in cash. But the broker MUST be a SIPC member for the investor to be protected. For the small investor we are covered for the time being. But this raises concerns for person's nearing retirement with large IRA's. The viability of a firm is vital. As with diversifing bank deposits with different banks to mitigate risk, this suggests that over the long term one should have more than one retirement account if possible and at different brokerage firms. This is a subject for a future post. As of this posting I have confirmed that all brokers listed are members of SIPC. Before you open an account you should check and ensure they still are.
Let me spell out my criteria for best online broker. This will differ, perhaps significantly, from other blogs or websites. What may be right for you, if you have a larger portfolio or if you eschew penny stocks, could look completely different. This is by no means a definitive list, but it should suffice for the Chroma Investing Small Investor Portfolio. You will note that I go into some detail here, because the brokers are quite adept at hiding some fees behind a cute little asterisk. Also, commissions and fees change often. I was surprised how different some companies are since last year at this time when I went through a similar process. My apologies in advance if I missed your favorite broker. Some I eliminated for price, others for minimum deposit requirements.
1) I looked primarily for value in stock trading commissions. The intention is to have little or no mutual funds, ETF's or bonds traded in this portfolio. That does not mean they are not worth investing, simply that that is not the focus of this investing account. Consequently, factors that effect those type of investments have been ignored.
2) The total brokerage costs including commission & fees will need to be low, under $10/trade especially for Penny Stocks. There will need to be no or additional charges for buying penny or OTC stocks. There are lots of companies with value hiding in 99 cent store of investing, I would hate to miss them because my broker charged too much to trade them.
3) No inactivity or maintenance fees.
4) unlimited shares in a trade without additional fees. This is another way that brokers attempt to limit penny stock purchases. A stock trading at .25/share will require 4000 shares to invest $1000.
5) I will not include a comparison of margin account rates because I intend not to employ leverage of any kind. This means I will also not factor in options or contract prices.
6) I am assuming we will be placing all our orders online directly, with no broker assisted trades.
7) Since short term interest rates are effectively zero, I will not bother comparing interest rates, if any, that cash earns in a sweep account (although I may reconsider and update later, if this factor changes)
8) You may also want to include a No-IRA fee in your criteria. For the purposes of this blog I will not. But for me personally, in my IRA's I include this as important screen to minimize expenses.
I will discuss size of positions in another post. But one of the tricks in investing with a small portfolio is not getting killed by the fees. If you expect to have a total of 3-4 positions in the portfolio, at least in the beginning, each $500 invested will have a 1% purchase fee with a $5.00 commission and 1% exit fee. The result is that you must make 2% just to break even. That is not an onerous hurdle. Let's say we changed that to just $10/trade. Our total is then 4% to buy and sell a stock. That is, I think in the new normal era, perhaps too high a price to saddle yourself with. Of course, we have to balance commissions with other fees, particularly extra charges for Penny or OTC stocks.
So let's jump in and evaluate. First, I will screen out companies for various criteria, then discuss all that passing companies. Later I will give a quick comment on each company.
From this chart I can eliminate a few companies right away simply based on price. E*Trade, TD Ameritrade, & ThinkorSwim all charge $9.95. Think or swim had other negative factors which I detail below.
OptionsHouse, Scott Trade, SogoTrade & Tradeking (my favorite broker) are eliminated because they have Penny stock charges.
That leaves Charles Schwab, Choice Trade, Fidelity, Just2Trade, TradeMonster & Zecco. Fidelity and Just2Trade have too large a minimum balance requirement, so they are out. For investors, starting with larger sum in their investment portfolio, this arbitrary cut off may not apply. Of the remaining four companies two had IRA fees, Choice Trade, and Zecco, so if that is an important factor to you. Think twice. For the Chroma Investing Small Investor Portfolio it is not.
On an absolute price perspective you would have to narrow the choice down to ChoiceTrade or Zecco, at $5.00 and $4.50 per trade respectively. But finding the best broker isn't only about price.
O.k. so what I haven't mentioned, because it is so hard to judge, is what is offered for this price and how customer service is when things don't work out as expected. This is qualitative area where stats don't tell the whole story. Before I decide between these two brokers, I would like to hear from you. Do you have any experience with either ChoiceTrade or Zecco? Tomorrow I will call both and get a sense of their customer service. Then I will make a decision. I will post soon where I decide to open the account. Maybe I will open accounts at both and see what the process is like, before I fund the account.
Below are my thoughts on the companies on the comparison chart.
Charles Schwab- The original discount broker. In recent years their prices have not been competitive with other online discount brokers, that seems to have changed this year. They are a surprise late addition, because they have recently (Jan. 2010) lowered their per trade fee form$12.95, eliminated the number of shares that would be allowed per trade without additional fees. Schwab has banking options, including checking accounts.
Choice Trade- I had not heard of them until I started my research on discount brokers. Two things intrigued me. First, their overall good price and Second, they are offering a $50 bonus if you add a margin account and open your account for $2000. That is a quick 2.5% gain on my money. They are not a good choice if this was an IRA account because of the IRA fee.
E*Trade- I was surprised they made the initial cut, that is under $10. But ultimately they would be to costly for our tiny trading account.
Fidelity- Last year trades cost over $10. This is perhaps the biggest surprise. I have read about some complaints with their trading tools, but are supposed to have a lot of free research available on more than 4500 corporations.
Just2Trade- Their low, low per commission rate would be partially offset by their IRA fee for some investors. Their reputation, however, sucks. The longest complaint I read on any forum about any broker was about Just2Trade. If you believe that poster, they could not get anything right. Two things concerned me most. First, their customer service is not great. Second their cash balances are often inaccurate.
OptionsHouse- Another low priced commission house, seemed initially promising with their $2.95 commission, but their Penny stock surcharge begins below $2.00 and is $0.005/share. Moreover, anything over 50,000 share requires a separate over and brokerage commission.
Scott Trade- I have spoken to several investors who have been happy with Scott Trade and their moderately price $7.00 trade. Their commercials at least garner attention. But Scott Trade is a terrible choice for Penny stock investors. They charge 0.5% of the value of the purchase for Penny stocks. Even on a $500 investment that adds $2.50 and makes them uncompetitive.
Sogotrade- I heard negative things about Sogotrade even before I decided to include them in the comparison. But their price of $2.95 begged inclusion. Unfortunately, they also have 0.5% charge on Penny stocks, and frequent complaints about their their online trading platform.
TDAmeritrade- Another large brokerage company that recently dropped their commission to $9.95/trade. Much better deal are possible with you are frequent trader. Eliminated for price.
Think or Swim - I have used Thinkorswim for more than a year. They are eliminated for two reasons, First they limit their $9.95/trade fixed rate to 5000 shares, above that you pay a per share fee, and Second, I hate their web based interface. It is the least intuitive I have seen. It is shocking to me anyone likes it. I feel like I am transported back to the days of early DOS, where nothing made sense.
TradeKing- A solid company, with great customer service and good reasonable $4.95 commission. Unfortunately, for the purposes of the small investor portfolio the Penny Stock Charges forces their elimination.
TradeMonster- The most promising of all the brokers I never heard of. While their $7.50 commission is higher than I like, it has no Penny stock charges, shifting the balance in its favor. The interface allows all tools to be used in Paper Trading, making this a very interesting choice for a small investor who is also a beginner. The ideal Chroma Investing reader.
Zecco- The price you can't deny. $4.50/trade. If you are a frequent trader or have $25,000 in assets you get 10 free trades/month. On the plus side Zecco has virtual trading and FOREX trading. On the negative side they have a yearly IRA fee and on some forums some complaints about customer service. Perhaps the service is getting better.
Disclosure: I currently have accounts with TradeKing and ThinkorSwim, but do not have a financial relationship with any brokerage company including any not listed in my comparison. Although based on my research I intend to move my thinkorswim account.