5 Truths About Discount Brokers

Before the Internet, only the wealthy had access to the investment markets because of the high cost of brokers who had to execute the trades. All of that has changed, however, because 21st-century technology has allowed most stock trading to be executed automatically. The top discount brokers provide the portal to this electronic infrastructure at a fraction of the cost of a traditional broker.

But before you open an account, do your research. While discount brokers are the perfect choice for some investors, misconceptions about their business model could prove detrimental to your investment funds. Here are some truths about discount brokers to help you decide if they're right for you.

Discount Brokers Don't Have Fiduciary Responsibilities

If you have worked with an investment adviser, they may have been bound by fiduciary responsibilities. This means that they have to put your needs ahead of their own before they make recommendations, and they have to know your risk tolerance, goals, and other financial information. Ideally, a fiduciary "has your back" much more so than other professionals.

However, discount brokers aren't fiduciaries. If you purchase 500 shares of a highly volatile stock, they probably won't advise you of the risk that comes with such an investment. When you do your investing through a discount broker, you're largely on your own.

Additionally, the SEC states that investment advisors have fiduciary responsibility whereas brokers don't; they just have suitability standards; however, this area can be murky as the responsibilities between brokers and investment advisors often overlap.

Education Is Not Adequate

Discount brokers have educational events. If you've always wanted to learn to trade options, they might have an introduction to options class you can attend, free of charge.

What they won't tell you is that you may not have the knowledge or experience to be an options trader, even after the class. The more trading you do, the more money they make, and since options, bonds, and other products may come with higher commissions, they're happy to see you try something new.

Those trader workshops are worth attending, but do a lot of paper trading before committing real money.

It Might Not Be a Discount

If you switch from a broker-dealer to a discount broker, you'll probably see a sizable discount. However, if you're a frequent trader and trading securities other than stocks, ETFs, or mutual funds (most discount brokers don't charge for trading stocks, ETFs, or mutual funds), commission costs can add up.

For example, buying 100 futures contracts with a discount broker could easily cost at least $150. Over time, these costs add up. Be careful how you trade and how often.

Different Discount Brokers Offer Varied Levels of Service

There's no doubt that there are a lot of discount brokers to choose from but each provides a different level of service. If you're the type of person who doesn't need any human contact, the cheapest of the discount brokers may work for you.

If you want to be able to stop by a branch office and have a market discussion with a broker, you'll have to pay a little more per trade.

Some of the full-service brokers offer stripped-down services that allow clients to make trades online with the help of one of their full-service brokers.

Discount Brokers Aren't Just for Small Portfolios

If you're a person with a higher net worth, the old assumption that discount brokers are for people with a small balance trying to make a quick buck isn't true.

All trades, regardless of the size, take your money to the same stock market, and although some brokers will tout that they can execute your trade a split second faster than somebody else, that is rarely important to longer-term investors.

If you have the knowledge and experience to manage your own money, paying a higher commission per trade with a full-service broker may not be necessary.

The Bottom Line

Discount brokers not only serve to remove advisory fees for people who can manage their own investments, but trades are cheaper and hassle-free. However, these brokers are only well suited for people who have the knowledge and experience to manage their money wisely. For most people, keeping retirement money in the hands of a professional is still well advised.