What we considered in picking a brokerage for our non-retirement trading – Part 1

December 7th, 2008 · No Comments

As part of our plan for reaching our geographic independence goal, we’ll start out by doing some investing (as purposefully opposed to trading.)  The problem we’ve been struggling with is trying to figure out what brokerage to use to do this.  Here is the top 6 of our list of the 13 things we thought about when making our decision.

  1. Type of investments we’ll be making.  This is important because each brokerage is really targeted to a certain type of customer, whether trader or investor.   For example, those who’ve already decided they want to invest in low-cost mutual funds are likely to find better account features and costs at places like Vanguard or Fidelity vs somewhere like TradeKing or Zecco.

    In our case, we’re planning to periodically invest in individual stocks, for their dividend payouts, or ETFs, for diversification purposes.  This means we should really focus on firms that target lower-cost trades.  Unfortunately for us, this doesn’t really weed out too many brokerages from consideration since almost everyone seems to have a program that competes in the trading market, though it does make some brokerages more likely than others.

  2. Initial investment amount.  This is critical to consider for two reasons.  First, a number of brokerages require a minimum portfolio size to even open an account.  Second, it sets the level for which we’ll compare the other factors.  For example, some firms charge an annual account maintenance fee if our portfolio is smaller than a certain amount.   Similarly, some firms charge lower transaction fees if our portfolio is above a certain amount.

    In our case, we are pretty much starting out with a new $0 portfolio since we don’t want to raid our retirement accounts, liquidate other assets, nor lock up already liquid assets to seed this account. This took out of further consideration any brokerage that requires a minimum portfolio size, such as Fidelity which requires $2.5K to start.  And it also meant that we couldn’t qualify for Zecco’s 10 free trades per month as you need a $2K starting portfolio to quality for that.

  3. Trading transaction costs.  This should be a big consideration for everyone and not just us, as transaction costs come off the top of every amount you invest.  Obviously we want this as low as we can get, and a number of people will tell you this should never amount to more than 1% of each investment you make.

    Since we’ll be investing a portion of our active income plus all of our passive income each month, and these amounts aren’t exactly huge (yet), we absolutely need to get these very small or else we should consider building up the amount over more than one month before making an investment transaction.  We’ve agreed to restrict ourselves to paying no more than a 1% transaction cost on purchases.  Which really means that finding a low cost broker determines how often we can convert cash to an investment.  From our initial survery, ShareBuilder comes out on top here if we’re willing to do their automated, trade-on-Tuesdays, program.  With our Costco-affiliated rebates there, our cost would be $3/trade.  Actually, Sogotrade matches that without any special program.  Zecco was the next lowest we found at $4.50/trade, though TradeKing at $4.95/trade wasn’t much higher.  Everyone else we found had a higher cost.

  4. Ability to put all of your money at work.  Some brokerages will allow us to initiate investments by purchasing fractional shares of stocks and ETFs just as if we were buying mutual funds.  This means we could invest in high-priced stocks and ETFs that would otherwise be out of reach for the new investor.  As well as allowing us to convert all of our cash to investments at the time we chose instead of waiting to hit an integer multiple of the desired investment’s current price.  It also means we could start to diversify sooner, though we need to be aware of transaction costs when doing this.

    As mentioned above, we’re not starting out by investing thousands of dollars per transaction so brokerages that allow this for new investments are very attractive to us.  As far as we’ve found, there is only one brokerage that advertises doing this — ShareBuilder.  There may be others that do it, but after a lot of looking, it sure isn’t common, or at least commonly advertised.  I have e-mailed a couple places to find out for sure whether they do it but don’t have responses yet.

  5. Cost of reinvesting dividends and capital gains.  Many brokerages allow free reinvestment of dividends and capital gains in mutual funds, but few seem to make it clear whether reinvestments in stocks and ETFs incur charges.  If we have to pay a fee, even a minimal one, and don’t have tens of thousands invested in the asset generating the income, it generally means we shouldn’t be doing this or the transaction fees will be way more than the 1% cost-rate we want to target.

    In our case, we found that ShareBuilder advertises no fees for reinvestments but we’re unable to find such declarations on any other brokerage site we looked into.  However, places like Zecco that advertise completely free trades could give you the same thing, at least after your portfolio reaches the $2K size to qualify for those free trades.  And until you are getting more than 10 dividend payments per month.

  6. Allowed transaction types. Many people will advise you to prefer limit orders over market orders, but not all brokerages allow limit orders, or allow them with their lower fee transactions.   For those who don’t know, a limit order allows you to specify a maximum or minimum value at which the trade should be made.  For example, a limit order to buy is where you specify a maximum you are willing to pay per share and the trade only gets filled if that price can be met or beat.

    This was actually somewhat of a negative for what was looking to be our front-runner so far as ShareBuilder’s low-cost, automated transactions only happen at market prices sometime on Tuesdays.   On the other hand, Zecco allows limit orders as part of their 10 free trades.   And it appears almost all other brokerages allow limit orders at the same price as market orders.

Stay tuned!  In the next day or two I’ll post the other 7 items we considered, plus tell you who we’ve decided to go with, as well as a summary of why.

EDIT: Part 2 of our thoughts on picking a brokerage is now available.

Tags: Brokerage

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