Why Discount Brokerages Change Everything

The big benefit of discount or online brokerages over traditional full-service brokerages is of course, low cost. Instead of paying a $150 commission to buy $5,000 worth of an exchange traded fund or individual stock, a typical discount brokerage customer pays under $30, and often under $10, provided they have enough money in the account – usually $50,000 or $100,000.

True, the full-service brokerages will say they provide ongoing comprehensive advice. But as we’ve argued in this blog and in the book, discount brokerage customers can also get advice by contracting for it separately via a fee-only financial planner.

It’s also true that such investors can further save costs by buying ETFs instead of higher-priced, actively managed mutual funds, which typically still impose the embedded-compensation costs of trailer commissions even for discount broker customers who aren’t getting the full-service advice that trailer commissions are supposed to be facilitating! This isn’t fair and has long been something of an outrage.

I dare say there are many do-it-yourself investors who would welcome the chance to get the stock-picking prowess of major financial firms as long as the fee was lower by the amount of the jettisoned trailer commission. Sadly, that doesn’t happen when you buy them at discount brokers: F class mutual funds do strip out the trailers but only if you buy them from a fee-based advisor who adds back in the equivalent charge of their own fee.

But discount brokerages also let investors in effect build their own mutual fund. I have to give credit for this idea to Norman Rothery, who is the stock guru at MoneySense Magazine, although I knew him long before I started working with him again in this new role.

Norm argues “discount brokerages change everything,” because the $10 per trade commission means you can in effect create your own index fund or ETF. Take the Dow Jones Industrial Average or the “Diamonds” ETF (ticker DIA/NYSE), which owns 30 top, large U.S. stocks like General Electric and Exxon. It would be expensive to buy those 30 stocks at a full-service brokerage but consider that at $10/trade it would only cost $300 to buy all 30 at a discount broker. Say you planned to contribute $10,000 to your RRSP this year. At a full service broker, it would make sense to buy only two stocks if you hoped to keep the commission cost to within 2 per cent of your purchase price. But at a discount broker, you could buy 30 positions of $333.33 each in all 30 stocks: in effect you’ve bought an equally weighted version of the Diamonds ETF and except for the one-time sales charge, you would not even have to pay the ongoing modest annual management fee charged on the ETF!

It’s an intriguing and potentially powerful idea.

Jonathan Chevreau is editor of MoneySense magazine and author of Findependence Day, available at www.findependenceday.com.

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