Distinguish between Full-Service and Discount Brokers

Stockbrokers fall into two basic categories: full-service and discount. The type you choose really depends on what type of investor you are. In a nutshell, full-service brokers are suitable for investors who need some guidance, while discount brokers are better for those investors who are sufficiently confident and knowledgeable about stock investing to manage with minimal help.

1. Full-service brokers

Full-service brokers are just what the name indicates. They try to provide as many services as possible for investors who open accounts with them. When you open an account at a brokerage firm, a representative is assigned to your account. This representative is usually called an account executive, a registered rep, or a financial consultant by the brokerage firm. This person usually has a securities license and is knowledgeable about stocks in particular and investing in general.

What they can do for you

Your account executive is responsible for assisting you, answering questions about your account and the securities in your portfolio, and transacting your buy and sell orders. Here are some things that full-service brokers can do for you:

• Offer guidance and advice. The greatest distinction between full-service brokers and discount brokers is the personal attention you receive from your account rep. You get to be on a first-name basis with a full-ser-
  vice broker, and you disclose much information about your finances and financial goals. The rep is there to make recommendations about stocks and funds that are hopefully suitable for you.
• Provide access to research. Full-service brokers can give you access to their investment research department, which can give you in-depth information and analysis on a particular company. This information can be very valuable, but be aware of the pitfalls.
• Help you achieve your investment objectives. Beyond advice on specific investments, a good rep gets to know you and your investment goals and then offers advice and answers your questions about how specific investments and strategies can help you accomplish your wealth-building goals.
• Make investment decisions on your behalf. Many investors don’t want to be bothered when it comes to investment decisions. Full-service brokers can actually make decisions for your account with your authorization. This service is fine, but be sure to require them to explain their choices to you.

What to watch out for

Although the full-service brokers, with their seemingly limitless assistance, can make life easy for an investor, you need to remember some important points to avoid problems:

• Brokers and account reps are still salespeople. No matter how well they treat you, they’re still compensated based on their ability to produce revenue for the brokerage firm. They generate commissions and fees from you on behalf of the company. (In other words, they’re paid to sell you things.)
• Whenever your rep makes a suggestion or recommendation, be sure to ask why and request a complete answer that includes the reasoning behind the recommendation. A good advisor is able to clearly explain the reasoning behind every suggestion. If you don’t fully understand and agree with the advice, don’t take it.
• Working with a full-service broker costs more than working with a discount broker. Discount brokers are paid simply for performing the act of buying or selling stocks for you. Full-service brokers do that and more.
• Additionally, they provide advice and guidance. Because of that, full-service brokers are more expensive (through higher brokerage commissions and advisory fees). Also, most full-service brokers expect you to invest at least $5,000 to $10,000 just to open an account.
• Handing over decision-making authority to your rep can be a possible negative because letting others make financial decisions for you is always dicey — especially when they’re using your money. If they make poor investment choices that lose you money, you may not have any recourse because you authorized them to act on your behalf.
• Some brokers engage in an activity called churning. Churning is basically buying and selling stocks for the sole purpose of generating commissions. Churning is great for brokers but bad for customers. If your account shows a lot of activity, ask for justification. Commissions, especially by full-service brokers can take a big bite out of your wealth, so don’t tolerate churning or other suspicious activity.

2. Discount brokers

Perhaps you don’t need any hand-holding from a broker. You know what you want, and you can make your own investment decisions. All you want is someone to transact your buy/sell orders. In that case, go with a discount broker. They don’t offer advice or premium services — just the basics required to perform your stock transactions.

Discount brokers, as the name implies, are cheaper to engage than full-service brokers. Because you’re advising yourself (or getting advice from third parties such as newsletters or independent advisors), you can save on costs that you incur when you pay for a full-service broker.

If you choose to work with a discount broker, you must know as much as possible about your personal goals and needs. You have a greater responsibility for conducting adequate research to make good stock selections, and you must be prepared to accept the outcome, whatever that may be. For a while, the regular investor had two types of discount brokers to choose from: conventional discount brokers and Internet discount brokers. But the two are so similar now that the differences are hardly worth mentioning. Conventional discount brokers primarily conducted business through regular offices and over the phone, while Internet discount brokers conducted business primarily through Web sites. But through industry consolidation, most of the conventional discount brokers today have fully-featured Web sites, while Internet discount brokers adapted by adding more telephone and face-to-face services.

What they can do for you

Discount brokers offer some significant advantages over full-service brokers, such as:

• Lower cost: This lower cost is usually the result of lower commissions, and it’s the primary benefit of using discount brokers.
• Unbiased service: Discount brokers offer you the ability to just transact your stock buy and sell orders only. Since they don’t offer advice, they have no vested interest in trying to sell you any particular stock.
• Access to information: Established discount brokers offer extensive educational materials at their offices or on their Web sites.

What to watch out for

Of course, doing business with discount brokers also has its downside, including the following:

• No guidance: Because you’ve chosen a discount broker, you know not to expect guidance, but the broker should make this fact clear to you anyway. If you’re a knowledgeable investor, the lack of advice is considered a positive thing — no interference.
• Hidden fees: Discount brokers may shout about their lower commissions, but commissions aren’t their only way of making money. Many discount brokers charge extra for services that you may think are included, such as issuing a stock certificate or mailing a statement. Ask whether they assess fees for maintaining IRAs or fees for transferring
  stocks and other securities (such as bonds) in or out of your account, and find out what interest rates they charge for borrowing through brokerage accounts.
• Minimal customer service: If you deal with an Internet brokerage firm, find out about its customer service capability. If you can’t transact business at its Web site, find out where you can call for assistance with your order.

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