Whether you’re an active day-trader who makes several trades a week, or a patient buy-and-hold investor who just makes a few trades a year, you should care about broker costs. That’s because keeping more of your hard-earned money on the front-end lets you grow it faster in the stock market – and keeping more on the back end means bigger net profits after all of the fees are accounted for. In fact, limiting your trading costs is often easier and more effective than trying to pick better-performing investments.
I’ve been trading for nearly 10 years now, and am a cheapskate by nature – so I’m kind of a geek about finding fees hidden in the fine print. That’s why I analyzed the 10 most popular online brokers that claim to be “discount,” while still offering a quality trading experience, to find the best.
Ally Invest is simply the most affordable broker there is, with its great rebates and super-low commission structure. You won’t find lower fees anywhere, and it still offers a quality trading platform. But for buy-and-hold investors who don’t really need access to the entire universe of stocks and ETFs, the nearly 100 commission-free funds offered by Fidelity will allow you to buy core investments in a cost-effective way while still having the flexibility to make more tactical trades without breaking the bank.
The Simple Dollar’s Top Picks for Best Discount Brokers
I looked for the cheapest possible brokers that still offered a quality trading experience, and found two that offer incredibly cost-effective trading, but don’t sacrifice the quality of the experience along the way, including tools and other extras.
Why Cheaper is Always Better for Investors
We are living in a golden age for small-time investors. Market data that was once exclusive to well-heeled money managers is now free to anyone with an internet connection via sites like Google Finance. Modern technology has reduced “friction” in transactions to make them cheaper, easier, and more transparent than ever before.
One challenge of this modern investing landscape, however, is what some experts call the “paradox of choice.” If regular folks have more ways to invest than ever before, how do they pick the right one?
The answer is actually simpler than you think. For most investors, the cheaper choice is always better.
You may be wondering why keeping your broker’s costs down is so important. Well don’t take my word for it – take billionaire Warren Buffett’s.
Back in 2008, the iconic investor bet some bigwig hedge fund managers $1 million that they couldn’t make more money over the next decade than a cheap, simple “index fund.” These investments are a boring, fixed portfolio of stocks that don’t change – and thus, don’t charge a lot of fees. Meanwhile, complex hedge fund strategies chase the latest fads and rack up big costs along the way.
This $1 million contest will end in about a year, but Buffett is so far ahead that it’s all but certain he’ll come out the winner.
This seems incredibly counterintuitive to regular Americans who think there’s a lot of mystery around the stock market. How can you just set it and forget it, and end up beating high-priced money managers?
It’s all about net returns – that is, your total investment profits after fees.
Just look at the following scenarios:
- You put $1,000 in a stock and the investment goes up to $1,200. If you have zero transaction fees, you make $200 or 20%.
- Your initial $1,000 grows to $1,200 but your broker charges $10 to buy the stock and $10 to sell it. You make $180 or 18%.
- Your initial $1,000 grows to $1,200 but you have an overpriced financial advisor who charges a flat 2% on your assets ($20 on the $1,000 investment) and 20% of all potential profits ($40 of the $200 in profits). Minus that $60 in fees, you make $120 or 12%.
How Fees Affect Your Net Profit
|Initial Investment||Gross Gains in Stock Market||Fees Charged||Ending Balance||Net Profit|
|$1,000||10%, or $100||None||$1,100||10%|
|$1,000||10%, or $100||$10 to buy, |
$10 to sell
|$1,000||10%, or $100||2% of assets, |
20% of profit
|$1,000||20%, or $200||None||$1,200||20%|
|$1,000||20%, or $200||$10 to buy, |
$10 to sell
|$1,000||20%, or $200||2% of assets, |
20% of profit
|$1,000||30%, or $300||None||$1,300||30%|
|$1,000||30%, or $300||$10 to buy, |
$10 to sell
|$1,000||30%, or $300||2% of assets, |
20% of profit
As you can see, fees really eat into your gains. And if that last example seems obscenely expensive, it isn’t – and is common enough to simply be known in Wall Street parlance as a “two and twenty” fee structure.
That means in order to make the same net return, your performance has to be a whole lot better to offset the additional costs.
It’s telling that despite one of the best track records on Wall Street, even Warren Buffett knows how hard it is to consistently put up huge gains to justify huge fees. So he’d rather focus on what he can most control effectively in the long term – costs.
How I Found the Best Discount Brokers
If you’re a typical investor interested in simple trades using conventional stocks and cost-efficient ETFs, with just a handful of transactions each month, there are plenty of ways to achieve your goals at a rock bottom cost.
The main fees I looked to limit:
- Costs per Transaction: For most investors, transaction fees or commissions are their biggest cost base. Therefore, a good discount broker will give you a bunch of free trades when you start, a bunch of transaction-free ETFs to make tactical trades on the cheap and a locked-in structure that’s affordable forever. A typical unassisted transaction fee is about $8 at present.
- Charges for Data or Tools: There’s a lot of sophisticated market research out there, but some of it is a luxury for most traders and not a necessity. Cutting out these top-shelf offerings can really keep costs down. At the same time, however, I insisted on a minimum standard for market data that included real-time quotes instead of a big delay, as well as stock screening tools and educational resources. Low cost doesn’t have to mean low quality.
- Extras with Extra Costs: Many brokers will tout that they have financial experts available 24 hours a day to help you make a trade, but they often like to hide that those services come at an additional fee. For instance, that typical $8 transaction fee can often rise to $25 or more if you talk to a human being in person or on the phone. Others are happy to offer free education about sophisticated strategies like options or futures, but make you upgrade your trading software to a platform that charges hundreds of dollars in annual fees.
- Account Minimums: It’s never any fun to watch your hard-earned cash dwindle thanks to a tough market or a bad investing idea. But it’s even worse if your broker has a minimum balance requirement that starts eating away at your savings even more.
Every investing strategy is different, of course, and some strategies like trading on margin – that is, using borrowed money from your broker to bet on ideas – always come with a significant cost and additional risk. However, these items are the cost centers for the vast majority of individual investors and the ones I focused on limiting as much as possible.
Sophisticated strategies like day trading are almost necessarily high-cost endeavors, simply because there’s a higher volume of transactions and deeper research that is required. If this is your strategy, then I encourage you to check out my review of the Best Day Trading Platforms – which includes my selection for the Best Low-Cost Day Trading Platform.
The Best Discount Brokers
Best Discount Broker Overall
Ally Invest offers the absolute lowest fee structure out there at $4.95 a trade, a price that’s matched by one or two other players like OptionsHouse, but never beat. That rock-bottom pricing puts it at the front of the pack alone, but on top of those regular, locked-in savings via low fees, Ally Invest is currently offering some really valuable perks if you open a new account – including $1,000 in rebates for your trades if you deposit $5,000 or more. That’s a modest amount of cash, but a very reasonable figure for even small-time investors. But even if you only move $100 over, you’ll still get $100 in rebates – good for 20 free trades at Ally Invest’s standard pricing.
Ally Invest is among the best discount brokers even without these offers. But the fact that there are valuable introductory offers above the great baseline pricing is the icing on the cake. I should point out that Ally Invest was recently acquired by Ally Bank, but according to its site, the interface will stay the same, and “for the foreseeable future there’ll be no change in pricing for Ally Invest clients, including Securities, Advisors, and Forex clients.”
That philosophy of giving something to everyone is also present in its tools, which range from sophisticated forex platforms for the high-octane world of currency trading, to education about mutual funds for conservative retirement investors. Some brokers focus on a certain kind of options trader or high net-worth investor, but Ally Invest offers a great experience for investors of all kinds.
Cash Back if you Switch
It’s not just the offer of cash back for new account holders that makes Ally Invest enticing. The discount broker also is eager to win your business, offering rebates for balance transfers and wire fees – annoying charges that your old broker may tack on if you choose to cash out your account. Sometimes investors get stuck on an inferior platform because they don’t want the hassle of switching, but getting up to $150 back in transfer charges can go a long way towards easing your transition to a new and better platform. It’s worth noting this is only a one-time thing, but the perk is nice.
Great Trading Tools
With the focus on cost, you may think Ally Invest would skimp on some services for the more active traders out there. But whether it’s a sophisticated calculator to explore Option Greeks or a profit/loss estimator to help you understand the risk and reward of your latest idea, Ally Invest has you covered. Most interestingly to me personally was the online Trader Network that allows individual investors to chat with each other in the platform as they trade. Seeing the experiences of real people can be educational, and help you uncover ideas in real time that you may miss by simply reading headlines.
Best Discount Broker for Buy-and-Hold
If you’re an investor who prioritizes low-cost index funds or long holding periods for tax-efficient gains, then you probably think Vanguard is the way to go. But while it’s true that Vanguard is the low-cost leader – and continues to suck up hundreds of billions of dollars in new assets as a result – investors must play within the Vanguard sandbox in order to realize those savings. If you want to trade stocks or funds by some other provider, expect to pay as much as $20 a transaction.
Fidelity, on the other hand, offers a similar suite of commission-free index funds under its own name, but also allows you to explore the rest of the market in a cost-effective way.
It’s the best of both worlds, with free transactions for the most popular funds and competitive pricing for those who are feeling a bit more adventurous.
And with a great introductory offer to big account holders that lets you trade commission free for the first six months, you can effectively waive all your trading fees for the next year or two – leaving more of your investment gains in your pocket.
If you’re an active trader, then Ally Invest is better because of a lower standard fee structure. However, buy-and-hold investors can take advantage of this great introductory offer for six months and then rely on the robust list of commission-free ETFs to meet all their needs going forward – for a cost that is effectively zero.
Highly Decorated Provider
Kiplinger’s 2016 Online Broker Survey ranked Fidelity No. 1 overall in a head-to-head with seven major brokers. Barron’s 2016 Online Broker Survey pitted Fidelity against 15 other platforms and earned the top overall score of 34.9 out of a possible 40.0. And Investor’s Business Daily ranked Fidelity among its top five brokers in a host of categories including Site Performance, Research Tools, and Customer Service. Even The Simple Dollar gave Fidelity an “award” previously in my review of the Best Online Brokers for Beginners.
When you have this many people singing your praises, it’s for a reason. And it’s particularly noteworthy that these awards are for quality – not simply for being the cheapest. That means you can have confidence you’re getting a great brokerage platform even as you look to keep down costs.
Great ETF Research Tools
Of course, one of the other reasons that I highlighted Fidelity as one of the best brokers for beginners was its accessibility and its tools. Of particular interest to buy-and-hold investors will be the ETF screener that allows you not just to sort by investment strategy, but also by expenses – including a box to check if you want to only explore Fidelity’s commission-free offerings.
The tool really takes the guesswork out of finding the best funds, and comes complete with a video tutorial to ensure you make the most of it. A few other discount brokers do offer screeners, but none match the depth of Fidelity’s in such a user-friendly way.
A Word on Capital Gains Taxes
It’s worth mentioning that while your broker is a big cost center, your investing strategy itself can also be a big generator of expenses and fees.
Take capital gains taxes, for example: For a married investor who files jointly and has a household income of $120,000 a year, they would pay a 15% tax rate on profits for stocks held more than a year, but if that investor buys and sells within a few months, they would pay a 25% tax rate.
Or put another way, a $10,000 investment profit turns into $8,500 after a 15% tax if you held your stock for 366 days. If you hold for 365 days, that profit is just $7,500 after a 25% tax.
The philosophy behind a long-term vs. a short-term capital gains tax is that short term gains are common thanks to speculation like day-trading, while long-term gains often come from true “investment” in a business or idea. As such, the IRS wants to reduce the burden on patient investors who could actually be helping a business and the economy in the long-term.
Why the big difference with just one extra day in the above scenario? Well, frankly, it’s just arbitrary. The deadline between short-term and long-term had to fall somewhere, and the tax man has decided that one year is the cutoff.
If you’re sitting on big gains after just a few week, there is obviously a big risk to holding an investment for many more months, so maybe you opt to suffer the tax. But if you’ve already held for 11 months to get your gains, it may be worth it to hold just a little longer. All transactions and investments are different, of course, but the tax difference is worth taking into account.
A Word on Fund Fees, Too
Aside from the taxes you’ll pay on any gains, another big cost center for the typical investor can be the fees incurred by the mutual funds or ETFs you buy.
As I mentioned earlier, Warren Buffett beat his high-priced peers in the hedge fund industry not by racking up bigger gains, but simply by reducing costs. So while doing your due diligence on brokers is great, make sure you look very closely at the so-called “expense ratios” of any mutual funds or ETFs you purchase in your account – even if you’re buying them commission free.
These expense figures are expressed as percentages, so seem small, but can wind up being deceptively large. Take one specific ETF, the PowerShares KBW High Dividend Yield Financial Portfolio (KBWD) that charges 3% or so annually in expenses. That may not sound like a lot until you consider it’s $300 each year for every $10,000 you invested. Or more plainly, that means this fund needs to generate 3% or $300 in profit each year just to break even.
With high-priced mutual funds and ETFs like these, however, the fees aren’t deducted from your account balance. They are simply shaved off the price you’ll see on the ticker tape. In the case of KBWD, those high expenses are a big reason this ETF’s value per share has gone nowhere in the last year or so – because any gross gains of the underlying investments have been offset by sky-high fees.
Other Common Fees
Broker fees, taxes, and fund expenses are by far the biggest cost centers to watch out for; however, there are other costs and fees you may encounter, too.
Mutual Fund Loads: In addition to base expenses they charge you annually, some mutual funds also charge you a fee either upon purchase (a “front-end” load) or upon sale (“back-end” load). These can average 0.5% to 1.0% of your investment, which can really add up.
Bid-Ask Spreads: The “bid” is what someone is willing to pay to buy an asset, and the “ask” is what someone is willing to sell. If you’re not using the latest data, you may bid $10.50 for a stock that other investors are actually selling at $10.45 for, and then a high-speed computer will happily buy from a third party at $10.45, sell to you at $10.50 and pocket a nickel per share in profits. Both Ally Invest and Fidelity will prominently display the “bid” and “ask” when you place an order, as do many other brokers, but it’s on you to check it. While more of an indirect cost, inefficiencies in the bid-ask spread can add up.
There are many more fees out there you may run across, too, depending on your investing style. So always read the fine print, and look to save money where you can.
Ally Invest or Fidelity are going to be your best options for keeping your broker fees as low as possible, which means keeping more of your money, both in your initial investment and in the profits you take out at the end of the transaction. If you’re an active trader, go with Ally Invest for the lowest possible fee structure. If you’re a buy-and-hold investor, Fidelity is going to give you the most tools to trade effectively while still offering an extremely low fee structure.