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How does a discount brokerage firm work?

POSTED: July 24, 2008 5:00 a.m.

In the past few weeks we have looked at: 1) a broad overview of different kinds of investments and 2) no load mutual funds. This week we’ll discuss in more detail how a discount brokerage firm works.

I feel that it is important to note that many different discount brokerage firms are broadening their offerings to include services that we will not discuss here. This is an overview and it is important to do your homework to make sure that a firm offers what you want before investing with them.

A discount brokerage firm allows individuals the opportunity to purchase and sell different securities — most commonly stocks, bonds, mutual funds, and money market funds. Most will also offer margin accounts and options trading as well. (A margin account is an account that allows an investor to buy and sell investments with borrowed money. Trading options is basically buying or selling the option to purchase or sell a specific investment at a future date. Both of these tend to be more complicated and carry significant risks and, for that reason, I recommend only very savvy investors even consider trading on margin or trading options at all.)

Discount brokerage firms will typically only carry out a client’s orders to purchase or sell an investment, but they will not normally give counsel as far as which investment is best for the investor’s situation. This is the first and most important distinction: The investor will have to decide what to purchase on his or her own.

Because discount brokerage firms typically do not have to pay someone to give advice to the investor, they are able to offer trades at a low cost. Therefore, the second point is: Discount brokerage firms are usually the least expensive way to buy or sell stocks.

Discount brokerage firms are typically available online or via a toll free 800 number. They will usually charge a low flat fee to purchase or sell stocks. This fee is often less than $20 per trade, (sometimes significantly less) though it varies from firm to firm. Some well-known discount brokerage firms are Charles Schwab, E*TRADE, Scottrade and TD Ameritrade.

In addition, most discount brokerage firms will offer a large selection of what they refer to as “no load, no transaction fee” mutual funds. There is a difference between loads (also known as commissions), transaction fees (something that brokerage firms will charge you to help cover their costs), and annual operating expenses (the fees that the mutual fund company charges for the management and administration of the fund). As stated last week, all mutual funds have annual operating expenses because someone has to handle the administration and management of every fund regardless of where you purchase it. However, you can often avoid loads and transaction fees when you use a discount brokerage firm.

All in all, discount brokerage firms can be very cost effective. They can also be very dangerous for a person that is not armed with discipline and knowledge. For those of you that love the idea of handling your investments on your own, make sure that you read a reputable book or two on investing before taking the plunge. If you are not confident in your ability to make both wise and unemotional decisions regarding your investments, do yourself and your family a favor and talk to someone who has the experience to help you make the best decisions.

Jeff Hupman is a financial advisor with Christian Values Investing. He can be reached at 748-9321. 

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