Securities transactions require the use of a licensed broker serving as a middleman between the seller and the buyer and collecting a fee on each purchase or sale of securities. A stockbroker (also known as an account executive) is licensed to buy and sell securities on behalf of the brokerage firm’s clients. You can buy or sell securities through an online or human stockbroker who works for a brokerage firm that has access to the securities markets. Brokerage firms often provide investors with investment advice. As a matter of convenience and to facilitate resale, investors prefer to leave securities certificates in the name of their brokerage firm rather than take physical possession themselves. Securities certificates kept in the brokerage firm’s name instead of the name of the individual investor are known as the security’s street name. Brokers have a duty to assess each client’s suitability for particular investments. Regulations also require that they disclose when they are selling securities owned by the firm for which they work. Figure 14.3 shows the flow of securities transactions
Discount, Online, and Full-Service Brokers
To trade securities, you will need a brokerage firm to act as your agent. You can open an account at a full-service general brokerage firm or a discount brokerage firm. Each charges a commission for any trading it conducts on your behalf. You should make clear to the brokerage firm, in writing, your investment objectives and your desired level of risk. You can open an account rather easily at any brokerage firm. A cash account requires an initial deposit (perhaps as little as $100) and specifies that full settlement is due to the brokerage firm within three business days after a buy or sell order has been given. After each transaction, your account is debited or credited and written confirmation is immediately forwarded to you. All brokers offer such services.
Discount, Online, and Full-Service Brokers
To trade securities, you will need a brokerage firm to act as your agent. You can open an account at a full-service general brokerage firm or a discount brokerage firm. Each charges a commission for any trading it conducts on your behalf. You should make clear to the brokerage firm, in writing, your investment objectives and your desired level of risk. You can open an account rather easily at any brokerage firm. A cash account requires an initial deposit (perhaps as little as $100) and specifies that full settlement is due to the brokerage firm within three business days after a buy or sell order has been given. After each transaction, your account is debited or credited and written confirmation is immediately forwarded to you. All brokers offer such services.
Discount Brokers
Many investors use discount brokers because they charge commissions to execute trades that are often 30 to 80 percent less than the fees charged by full-service brokers. These brokers feature low commissions because they have lower overhead and may offer fewer customer services. That is, they focus on a single function: efficiently executing orders to buy and sell securities. Some discount brokerage firms do not conduct research or provide investment advice. Transactions can be completed online as well as via a toll-free telephone number; investors can also obtain price quotes, check the status of their accounts, and transfer funds online or by phone. Discounters include Ameritrade, Scottrade, E*Trade, ShareBuilder, and BUYandHOLD.
Online brokers (also called Internet or electronic brokers) have reduced the cost of executing a trade to perhaps $20 or even $10 because their primary business is online trading. Online day trading occurs when an investor buys and sells stocks quickly throughout the day with the hope that the price will move enough to cover transaction costs and earn some profits. Day traders do not own stocks overnight. Transactions are executed online because they can be done quickly with low commissions. Day trading is a risky practice. One of billionaire Warren Buffett’s commandments for getting ahead in personal finance states, “You will lose money if you trade stocks actively.”
Full-Service General Brokerage Firms
A traditional general brokerage firm offers a full range of services to customers, including investment information and advice; research reports on companies, industries, general economic trends, and world events; an investment newsletter; recommendations to buy, sell, or hold stocks; execution of securities transactions by humans and online; and margin loans. Investors receive monthly statements summarizing all of the transactions in their account and commissions, dividends, and interest. Commissions and fees are higher than those of discount and online brokers; however, investors can discuss their investments
Broker Commissions and Fees
Brokerage firms receive a commission on each securities transaction to cover the direct expenses of executing the transaction and other overhead expenses. They have established fee schedules that they use when dealing with any except the largest investors. The fees reflect a commission rate that declines as the total value of the transaction increases. For example, in lieu of a minimum commission charge of $25, a brokerage firm might charge 2.8 percent on a transaction amounting to less than $800, 1.8 percent on transactions between $800 and $2500, 1.6 percent on amounts between $2500 and $5000, and 1.2 percent on amounts exceeding $5000.
Transaction costs are based on sales of round lots, which are standard units of trading of 100 shares of stock and $1000 or $5000 par value for bonds. An odd lot is an amount of a security that is less than the normal unit of trading for that particular security; for stocks, any transaction less than 100 shares is usually considered to be an odd lot. When brokerage firms buy or sell shares in odd lots, they may charge a fee of 12.5 cents (called an eighth) per share on the odd-lot portion of the transaction, which is called the differential. The payment of commissions can quickly reduce the return on any investment. A purchase commission of 2 percent added to a sales commission of another 2 percent, for example, means that the investor has to earn a 4 percent yield just to pay the transaction costs. Brokerage commissions typically range from $25 to 3 percent of the value of the transaction. The easiest way to hold down investing costs is to find abrokerage firm that charges low commissions.
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