In the old days, when our grandparents were just starting families and establish their own careers, the only way to invest was to visit your local broker. They would pay a small fee each time they purchased shares of a stock or mutual fund & would often pay an annual fee as well. It worked for them and many of our grandparents and great-grandparents were able to retire and not solely rely on Social Security security. While you still can invest with a broker to this day, the internet has made it possible for literally anybody to invest without broker assistance.
Why You Might Want a Broker
Every town with more than a few hundred people probably has a full-service brokerage like Edward Jones or Merrill Lynch to help people of all ages invest for the future in taxable accounts and retirement accounts. Even though the Internet has revolutionized many industries, neighborhood investment brokers aren’t going anywhere.
You might consider using a broker if you exhibit one of the following behaviors
- Know absolutely nothing about investing but know you should invest
- Like to leave the money management decisions to the “professionals”
- Prefer face-to-face conversations and advice from a somebody that trades stocks for a living
While there’s nothing wrong with using a broker if that’s the only way you feel comfortable investing, many people are missing out on maximizing their investing potential by not becoming a DIY investor.
A Traditional Broker Can Be Expensive
There are two different types of brokers. The first is a commission-based broker that collects a small fee (up to 5% usually) each time you buy a stock. For example, if you invest $1,200 a year, your broker might keep $60 for himself leaving you with $1,140 to trade.
Since commissions might motivate a broker to buy stocks that pad his wallet but underperform the market, proposed federal changes called the “Fiduciary Rule” are causing many brokerages to become a fee-based broker instead. This shift means brokers charge a flat fee of approximately (1.35%) of your total account value each year and eliminate sales commissions & reflects how many mutual fund companies to have slashed fees to attract new investors. Assuming you invest the same $1200 annually with a fee-based advisor, you will only pay about $16 in fees before any asset appreciation is included.
Online Brokerages Are Way Cheaper
If you sign-up for any big name brokerage (Schwab, Vanguard, Fidelity, etc.) you have the option to use their brokers for a fee or you can invest yourself. If you know what types of funds you want to invest in, you only pay the trade fee of $5 to $10 to buy a stock or ETF and often have the option to buy from a list of in-house mutual funds and ETFs with zero trading fees.
This last perk is what makes DIY investing so appealing. Many mutual funds offered by a broker have expenses as low as 0.03% and usually no more than 0.15%. Assuming you invest that same $1200 in an index fund with a 0.15% annual expense ratio and you will only pay about $2 in fees. If your fee-based broker was to buy the same fund, your expenses would essentially be at least 1%. Magnify that amount of fees over a lifetime of investing and you can literally be giving your broker thousands of dollars in fees that could have been invested had you bought the same fund yourself.
Most “Successful” Funds Are Run By Computers
Did you know that most mutual funds and stock brokers that try to “beat” the market fail more often than not? And, they charge higher fees than passive funds have a historically better performance history with fewer fees.
These low-cost funds are called index funds and simply try to match the performance of a particular market like the S&P 500 or the Dow 1000. Their costs are lower because they “buy and hold” the same 500, 1000, or 2000 companies instead of constantly selling by trying to predict the market. They are also run be computers that keep the allocation consistent.
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“Robo-advisors” Are Becoming Commonplace
I mentioned earlier that traditional brokers will not go extinct anytime soon, but, they are becoming less common. To fill the void, many discount brokerages have introduced “robo-advisor” funds that are is a portfolio of several ETFs managed by a robot. The two most popular companies built on this investing strategy are Betterment and Wealthfront, but, other online brokerages like Charles Schwab have also introduced their own robo-funds.
These funds try to strike a happy medium between total DIY investing and employing a traditional broker that are for investors that want to save by investing themselves but still want some expert guidance. Total fees for one of these accounts are near 0.30% and the robot does the mundane work of rebalancing your portfolio each year & doesn’t become too aggressive or conservative for your age as a traditional broker also does for most of their investors that consistently buy the same stocks & funds every month.
If you are not ready to stop using your broker and starting picking your own stocks, considering a “robo-adviser” can be worth the 1% drop in expenses from a fee-based broker and still allow the daily management of your money to be managed by a professional company.
Even Warren Buffett Says You Don’t Need a Broker
Finally, the most successful investor in our lifetime, Warren Buffett, recommends that the typical non-professional investor (you) primarily invest in index funds because of their low costs & consistently stellar performance history.
It doesn’t take a broker to buy an index fund. They can, but, it’s going to cost a lot of money that could be used to earn compound interest instead.
As so much of the market is automated, computers can trade quicker than any human and finds optimum buy & sell opportunities in a split-second that we never even knew existed.
Also, every human has emotions and it’s easier to buy high & sell low than we care to admit. Even the professionals use some level of emotion & guesswork when making their many investment decisions.
Not Sure How to Start Investing?
I opened up my first investment account back in 2012 after paying off a lot of debt. That account was with Betterment. Since then, I haven’t looked back. I love the simplicity and ease of use they provide. I think their system is good for any type of investor. If you want to get into investing, check out Betterment.