How do online brokerage firms work?
You can think of an online stock broker as a conduit to the stock exchanges. In exchange for a commission on every trade, the best stock trading platforms send your orders on to stock exchanges and market makers, which actually do the heavy lifting of matching your buy order with someone who wants to sell, or vice versa.
But you can’t just buy a stock through your bank account or call the company and buy shares — you need to find one of the best stock brokers to make a trade.
Fortunately for everyday investors, the brokerage industry has changed dramatically over the past couple of decades. To buy a stock, you used to have to call an individual known as a stock broker, who placed the order on your behalf. This process was complex — and expensive.
You and I can’t knock on the doors to the stock exchanges and make a trade without a stock broker. In truth, the stock exchanges as we think of them from their depictions in movies and on TV don’t really exist today. Most trading in the best online stock brokers actually takes place between computers in dimly lit server rooms in New Jersey, a few miles from New York City’s financial district.
With the best online stock brokers, placing a trade is similar to other types of online banking. It’s much more convenient than it used to be — and more accessible, too. You might say all you need is a brokerage account and a dream.
What is the difference between investing and trading?
Here at The Motley Fool, we believe in long-term investing as a proven strategy for investors to build wealth over time. That means we believe in buying and holding stocks for at least five years. Why? Because a buy-and-hold strategy ignores short-term volatility in the market and makes the most of the long-term potential of investing.
Trading, on the other hand, involves buying and selling after holding them for short periods of time. It’s considered riskier than long-term investing. In the short-term, anything can happen. Investing consistently over many years, conversely, has a much higher likelihood of success.
Types of brokerage accounts
Today, instead of using the term “stock broker” as an all-encompassing term for any person or brokerage firm that deals in stocks, we generally divide brokerages into two categories: “discount brokers” and “full-service brokers,” labels that better describe what stock broker companies actually do.
Discount brokers
Online brokerages are discount brokers. They aren’t in the business of giving you advice or phoning you up with stock picks. Instead, discount brokers focus on the very basic service of helping you buy or sell a stock (or other type of investment) from the convenience of your own home.
Because discount brokers forgo many of the frills, they can charge rock-bottom prices for their services. Virtually all online stock brokers charge $0 to place a stock trade — a bargain, especially considering what traditional brokers charge, and also charge low fees for other products and services. In addition, discount brokers tend to have lower minimum investment requirements (or no minimums at all), making them accessible to everyone.
Full-service brokers
Brokerage firms we label “full-service brokers” are more closely related to the stock brokers of days gone by. Full-service brokers often employ human brokers who can help you make a trade, find mutual funds to invest in, or make a retirement plan.
That said, full-service brokers are costly, since people are inevitably more expensive than computers. A popular full-service broker charges a minimum of $75 to place a stock trade, and that can jump to as high as $500 or more to buy a large amount of stock. Buying a mutual fund through a full-service broker can potentially set you back thousands of dollars, since they often charge fees equal to a portion of the amount you invest. Full-service brokers are more likely to have higher account minimums; some advisors only work with clients who have $1 million in assets or more.
Realistically, the lines between the two types of brokers are starting to blur. Discount brokers now have wealth-management services that offer the help of a human advisor at a full-service price. Some full-service brokers also offer a basic level of service at discounted prices. For example, Merrill Edge® Self-Directed is the discount brokerage arm of the full-service brokerage Merrill Lynch.
Which type of brokerage account is right for you?
The best online brokerage account for you depends on your needs. Here are a few things you might want to consider when comparing trading platforms:
- If you plan to simply buy and hold stocks, you probably don’t need a full-featured trading platform.
- If you primarily plan to buy mutual funds, you should look for the best mutual fund broker, since these brokerage accounts offer low to $0 commissions to buy and sell mutual funds.
- If you are a brand-new investor and only want to invest a few hundred dollars at first, you’ll probably want to look for the best brokerage firms with no minimum investment requirement.
If you plan on trading bonds or stock options, or plan on making trades over the phone as opposed to online, be sure to look at what each of the top brokers charge for these activities. Comparing the best investment brokers on our list can help you determine which platform has the features you’re looking for.
What to consider when comparing top brokers
Like most financial products, there is no brokerage firm that is a perfect fit for all investors. But here are some of the factors to keep in mind when you’re deciding which is the best online broker for you:
- Commissions and fees: Basic online stock and ETF trades should be free. The best stock trading platforms shouldn’t charge you these extra fees. Investors now pay $0 commissions at most online stock brokers, and some trading platforms even offer options trading for free, which can be particularly valuable for active traders. Most online brokerages charge commissions for mutual fund trades and other services you might need, so it’s still important to compare fee structures between stock brokers.
- Mutual funds: While most online brokers charge a commission for mutual fund trading, it’s also important to know that most trading platforms have a list of hundreds or even thousands of funds that trade with no commissions at all. These are known as no-transaction-fee, or NTF funds.
- ETF investing: The best ETF stock brokers will not only have $0 online commissions for ETF investing, but they also tend to offer access to a wide array of branded, low-cost ETFs. These branded ETFs are managed by the stock broker’s analyst teams themselves and they often include rock-bottom expense ratios.
- Options investing: A well-rounded stock brokerage account will not only offer access to investing in stocks, ETFs, and mutual funds, but also options. Some options trading platforms include $0 commissions for online options trades and high-quality trading software across online, desktop, and mobile devices. Many still charge a per-contract fee for options trading, although a few do offer completely free options trades.
- Account minimums: Many of the top online stock brokers don’t have account minimums, but a few do. If you’re a beginner investor, it’s important to verify that you can meet any minimum investment requirements before you select a broker.
- Trading platform: Some stock brokerage accounts have full-featured and complex online stock trading platforms and software available to frequent traders, as well as managed portfolio services from robo-advisors. Other stock brokers take a more simplistic, user-friendly approach. And many have top-notch investing apps that could come in handy if you want to buy and sell stocks from anywhere in the world.
- Research and screeners: One key reason to have an online brokerage account is that you can access a second opinion when you need it. Many of the best brokers offer a full suite of third-party research as well as stock and fund screeners. Others are designed to be low-frills platforms that simply make it easy to buy and sell stocks and other investments. With the best brokerage accounts, for example, you should be able to find the annual fees for investing in a fund, or get help sorting through your choices via parameters like price-to-earnings ratio.
LEARN MORE: How to Choose the Right Brokerage For You
Are online brokerage accounts safe?
Online brokerages are safe, and that’s especially true when it comes to all of the brokers discussed on this page. All of the best brokerage firms listed here are members of the SIPC, which stands for Securities Investor Protection Corporation, and this means that the cash and securities in your account are protected up to $500,000 in the event that the brokerage firm fails. Essentially, SIPC protection is to brokerage accounts what FDIC insurance is to bank accounts, but with one big difference.
The SIPC does not protect against losses that result from declines in the market value of securities. It protects as much as $250,000 in cash in your brokerage account, and while it doesn’t cover things like unauthorized trading activity, most of the best brokerage accounts have fraud protection guarantees that cover you in the event your account is hacked, as long as you notify them in a timely manner.
How to open a brokerage account
In most cases, the process of opening a brokerage account is rather quick and straightforward. But here are the general steps to opening a brokerage account once you’ve found the best stock trading platform for you:
- Learn about different types of brokerage accounts, and determine what type of brokerage account you need (individual, IRA, etc.)
- Compare different brokers to find the best brokerage accounts for you.
- Decide which brokerage firm is best for you.
- Fill out the new account application, and be ready to provide identifying information such as your Social Security number.
- Add funds to the account. Most brokers offer several ways to do this.
- Start investing!
