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Online trading has helped make investing more accessible to the masses. And to capitalize on this trend, many brokerage firms are increasingly offering low-cost services that were previously reserved just for wealthier individuals. Welcome to the age of the discount broker.
What does a discount broker do?
A brokerage firm acts as the intermediary between buyers and sellers, executing buy and sell orders at a stock exchange like the NASDAQ or the NYSE. For this service, brokerage firms would usually charge a fee. But as technology breaks down the barriers to entry and increases competition, most brokerage firms have been forced to adjust their business models to offer commission-free trading and more.
Unlike a full-service broker, which gives clients access to perks like personalized investment advice, estate planning — among other services — discount brokers tend to operate primarily on a self-service model. That means retail investors are more in charge of their financial planning.
Full-service brokers vs. discount brokers
By allowing investors to conduct their own research and investment management, discount brokers can eliminate overhead costs such as administrative and management fees. Often, discount brokers extend those savings to investors in the form of lower commissions.
With benefits like no minimum deposits, zero-commission trading, free learning tools, and more, discount brokers have leveled the playing field for novice investors.
Similarly, the internet has democratized access to information for everyone, empowering retail investors to learn about stock trading, investment management, and personal finance more easily. From having access to real-time quotes, company news, free investment webinars, and other learning tools – all from their mobile devices – retail investors are more empowered than ever before.
As a result, discount brokers are progressively becoming platforms that provide the average investor with similar tools and information as the pros. Along with discount brokers, new investment options like exchange-traded funds (ETFs) and robo-advisors help investors diversify their assets while keeping investment costs down.
How to know if a discount broker is right for you
For most investors, deciding whether to use a discount broker depends on your financial situation, investment knowledge, and goals. Also, it’s helpful to take a realistic assessment of whether you have the time to monitor your investments and make decisions that are not emotionally driven.
Many full-service brokers have wealth management teams of highly specialized individuals who can recommend investment strategies that do not apply to most average-income families. Additionally, some full-service brokers have high-minimum balance requirements, depending on the investor profile they are trying to attract. As a result, many full-service brokers are simply not open to everyone.
On the contrary, discount brokers may offer fewer benefits. For seasoned investors who are active in the market, discounted trading is the main draw. But retail investors can also benefit as they build their portfolios through investment products like low-fee mutual funds or ETFs, helping them diversify their holdings while keeping costs to a minimum.
Is your money safe with a discount broker?
Yes, discount brokers are a safe place to save and invest your money. In recent decades, discount brokers have grown to oversee massive sums of investor assets. Charles Schwab, one of the first discount brokers, held almost $8 trillion in client assets at the end of February 2022. Fidelity, another industry leader, had about 40 million individual investors as clients at the end of 2021. These companies have grown in large part thanks to the low costs and easy-to-use platforms they offer investors.
In the unlikely event that your broker fails, the Securities Investor Protection Corporation (SIPC) offers some protection. The SIPC is a federally mandated, private nonprofit organization and covers investors for up to $500,000 in securities and up to $250,000 in uninvested cash if a broker fails. You’re only protected if the broker becomes insolvent and the SIPC insurance doesn’t cover investment losses.
There’s no right or wrong answer when it comes to choosing a broker.
Instead, individual investors should be honest about their knowledge of investing and their willingness to put time and effort into managing their investments, such as rebalancing their portfolios. And even if a full-service broker is the better choice, investors should regularly engage with their finances to ensure they remain on track to reach their goals.