If you’ve never invested in stocks before and are about to buy some for the first time, you should understand what to look for and what factors to consider when selecting a stockbroker.
First of all, what is a stockbroker? Well, I’m not really sure……just kidding. A stockbroker is an intermediary between you and the stock market, which is an exchange where shares of stock in public companies are openly traded. When you buy or sell a stock, also known as a “security,” you must place the order through a broker, who then transacts your business by placing the order on the market.
Stockbrokers are basically salespeople. They work for brokerage houses. You’ve heard the names Merrill Lynch, Solomon Smith Barney, Goldman Sachs. Those are brokerage houses. Brokers work at those companies. Some brokers are paid a straight salary, some are paid a commission, and some receive a base salary in addition to their commission.
A full-service broker, much like a full-service gas station, advises you on which stocks to buy. Full service brokers are financial advisors, they tell you what to do. However, full-service brokers don’t always provide expert advice. Most of the advice they provide is based on research done by analysts who work for the brokerage house.
A discount broker is someone who gives you zero advice, and just executes your market orders for you, but does nothing else. Therefore, a discount broker usually doesn’t collect commissions. Instead, they usually charge a flat annual fee and are paid a salary. Internet brokers such as Etrade or Ameritrade are discount brokers that work on commission. They allow you to place your market orders online, and the website itself is the broker. Internet brokers usually charge a much smaller commission than anyone else.
A full-service broker offers a wider array of investment vehicles for you to put your money in, such as stocks, bonds, derivatives, annuities, and some also sell life insurance. A discount broker, on the other hand, doesn’t have access to all these investment vehicles. A discount broker makes money by opening up a lot of accounts and having a lot of customers, but a full-service broker makes money by placing a lot of trades within your account, because they receive a commission on each trade.
This is where you need to be careful. Full-service brokers make money every single time you place a trade. So, they have an incentive to persuade you to place a lot of trades, because that’s where they make their money. There are unscrupulous full-service brokers out there who do provide sagacious investment advice, but who are so active with your portfolio that their commissions start to eat away at your earnings. Neophyte investors have unknowingly hired these sorts of brokers, and when they get their annual statement they’re shocked to find that they made a lot less than what they thought, and in some cases actually got a negative return on their investments.
So, be careful when selecting your broker. If you hire a full-service broker, make sure it’s someone who works for or is associated with a reputable brokerage house, and make sure that the broker understands that you are aware of the fact that they make money every time a trade is executed. In this manner, they’re less likely to eat away at your capital unnecessarily, because they’ll know upfront that you’re hip to their game. If you know what stock you want to buy and are a small investor, it’s best to go with a discount broker, because they don’t receive commissions. and therefore won’t persuade you to place superfluous trades.