In order to invest money in the stock market you need a stock broker so that you can buy or sell stocks. Some stocks can be purchased directly from companies, but for most stocks, you will need to go through a broker or brokerage firm.
Although most people tend to think of stock brokers as the guys who frantically run around on the trading floor (floor broker), such as that of the New York Stock Exchange (NYSE), brokers can also include stock brokerage houses such as Charles Schwab or Merrill Lynch in addition to the individuals who work for such brokerage firms.
Note: A brokerage firm, also known as a brokerage, is a financial institution that acts as a go between for the buying and selling of stocks, or other financial derivatives, between a buyer and a seller.
The main role of a stockbroker is to act as a sales agent who carries out the buying and selling activities of securities. In finance lingo, securities refer to financial or paper investments, of which, stocks or shares are only a small part.
There are two main types of brokers that you can use to carry out your trades: a full service broker and a discount broker. Let’s take a look at each of these in more detail now:
Full Service Stock Brokers
Full service brokers, also known as advisory brokers, are the most expensive type of broker. This is because in addition to buying and selling stocks for you, they can also offer you investment advice or recommendations (i.e., an advisory dealing service).
This can be useful for people who would like extra information to carry out their own research with, or for people who are new to the stock market and would like some professional help with their trades.
Some of the things that a full service stock broker can do for you include:
Help & Advice
Your account representative will offer you help and advice when making investments decisions. Normally, you will talk with your representative on a first name basis and tell them about your current financial situation and your financial goals.
Based on what you tell your representative, they will then advise you on the best stocks and funds that are most suitable for you.
When investing in the stock market, you need to do a lot of research to ensure that you make the best investment decisions. A full service stock broker can help you do this.
For example, they will be able to provide you with information about a company that you might be interested in investing with, and information on other companies which they feel would be a good option for you.
Of course, this information may turn out to be inaccurate, so don’t invest in a company just because your representative says so without first looking at it closely yourself.
Your account representative should have a good idea of your investment goals so that they can work with you to achieve them.
They are also likely to review investment strategies with you and discuss how long it will take to reach your goals using those strategies.
If you build up a good relationship with a full service stock broker, you may feel as though you can trust them enough to make investment decisions on your behalf.
This saves you time from having to make investment decisions yourself, and can be an excellent way to invest if your broker has a good track record.
Things to Look Out For
Having a good broker can make things a lot easier when investing in the stock market, however, there are some things that you should be aware of as we shall now discuss below.
Brokers Earn Commission
Brokers are salespeople, and this means that they get paid to treat you nicely. Brokers generate commission and fees from you to the company who they work for, so don’t forget that, no matter how nice they seem.
Make Your Own Choices
A broker should be seen as a source of advice, rather than a final decision. Always make your own choices as to where you invest your money, and make sure that you fully understand why a broker is giving you a particular recommendation.
If you choose to go with a full service stock broker, rather than a discount broker, it’s going to cost you more.
A discount broker gets paid just to buy or sell stocks for you, while a full service broker also gets paid to give you advice on which stocks to buy or sell. So if you are not getting good advice from your broker you are needlessly wasting extra money.
If you allow your broker to control your investment decisions, then you are essentially handing them control over your money. If they make investments that turn out bad, you will lose money but they will still get paid.
So unless you feel as though you can absolutely trust your broker, don’t authorize them to make investment decisions on your behalf.
Because brokers get paid to buy and sell stocks, some brokers try to buy and sell as many stocks as they can just to make extra money for themselves.
This is called “churning”, and it is done in their best interest and not yours. So if you notice lots of activity going on in your account, make sure that you investigate it and ask for an explanation.
Discount brokers, also called non-advisory brokers, are cheaper than full service brokers, as they generally only carry out the buying and selling activities rather than giving you advice on how to invest your money (an execution-only service).
Such brokers therefore tend to be better suited for experienced investors who don’t require professional help or who can get the help/advice they need elsewhere.
Note: If a stockbroker is given the authority to make decisions on their client’s behalf, then this is referred to as a discretionary dealing service. This type of service is generally favored by passive investors who wish to expand their investment portfolio with minimal effort on their behalf.
There are two types of discount brokers that you can choose from; conventional brokers who do business via an office and phone, and internet brokers who do business via a website.
However, since most brokers now have a website, there is much less difference between a conventional and internet broker than there used to be in the past.
Some of the things that a discount broker can do for you include:
Discount brokers are cheaper than regular brokers. So if you have limited funds, they may be your best option.
Provide Unbiased Service
Since discount brokers only buy and sell stocks for you, and don’t give advice, they do not have a vested interest in trying to sell you a particular stock which means that you will get an unbiased service from them.
Large and well established brokers can offer lots of information to help you do research from their office or website.
Things to be Aware Of
There are some downsides to using discount brokers that you should be aware of, some of which are listed below:
Since discount brokers only buy and sell stocks, they don’t offer you any advice on your investment decisions. This means that you need to do your own research beforehand so that you know what you should buy or sell.
For people who are new to the stock market, this may pose a problem. So unless you are an experienced investor, you are probably best going with a full service broker.
Although it is true that most discount brokers have lower commission rates, they can still make money through fees.
For example, you could be charged extra for services such as issuing a stock certificate or mailing a statement, so you may be vulnerable to paying hidden charges which are not immediately apparent.
Although the primary role of a stock broker is to facilitate the buying and selling of stocks, there are other roles that a stockbroker can carry out. Some of these additional roles are listed below.
Some of the other roles carried out by a stock broker are listed below:
Stockbrokers can offer limited banking services such as fixed or variable interest bearing accounts, check writing, direct deposit/direct credit and credit cards.
Brokering Other Securities
Stockbrokers can also help you with making other forms of financial investments, such as buying bonds and mutual fund options.
How Does a Stock Broker Make Money?
Personal stockbrokers make money by helping other people to make investments and then charging a fee for their service. Some of the fees that a stock broker can collect from you include:
If you use a stockbroker to buy and sell stocks or other securities, you will be charged a fee for the service that they are providing you with.
This fee can vary depending on whether you are using a full service or a discount stockbroker, with full service stockbrokers being the most expensive to use as they can also act as an investment/financial advisor.
Brokerages make their profit on the difference between the highest price that a buyer is willing to buy at and the lowest price that a seller is willing to sell for.
This difference is known as the bid-ask or bid-0ffer spread. The smaller the margin or spread the better a deal the buyer will get, the larger the spread the more profit the stockbroker will make.
Note: Sometimes stockbrokers will offer their client a commission free purchase in order to sell the stocks that a specific firm wishes to off-load.
Margin Interest Rates
If you borrow against your brokerage account to make other investments, you will be charged interest on the amount that you have borrowed.
Various administrative tasks, such as mailing stocks in certificate form, usually involve a small service charge.
Size of Fee
The fee that you are charged will depend on the size of the trade that you are making, its value and the reputation or experience of the stockbroker that you are using.
Generally, fees will be lower for young or novice brokers as they usually start out on a salary payment structure, whereas more experienced brokers work on a commission or sales basis.
Note: Discount stockbrokers usually operate on a salary or sales basis, whereas a full service stockbroker will usually operate on a commission basis.
Making Sense of Recommendations
For many people, an important part of stock market investing is listening to their broker’s recommendations.
In fact, the views of some stock brokers, or stock market analysts, can cause the value of stocks to increase or decrease depending on what they have to say about a particular company. So it’s definitely worth listening to their recommendations, even if you don’t choose to follow them.
There are several types of recommendations, or advice, that stock brokers can give. Some of these are listed below:
Strong Buy and Buy
A strong buy and buy recommendation is given for stocks that you probably should buy because there is a good chance that their value is going to increase.
It is worth remembering though, that buy recommendations tend to be the most common type of advice given because brokers sell stocks and so can make money from commissions.
An analyst who gives this type of advice tends to have positive expectations about the performance of a particular stock, yet remains conservative in their advice because they cannot say for certain how those stock are going to perform.
This type of advice is usually a nice way of saying that you should sell your stocks.
When you are told to sell your stocks, then you probably should sell them because their value is going to decrease.
The sell recommendation is usually given as a last resort when things are looking really bad, and it can very often create panic amongst investors who try to sell before they reach the bottom.
Using an Analyst’s Recommendations
When investing in the stock market, you need to consider as much information as possible to ensure that you make the right investment decision.
A stock market analyst’s recommendations are just one of these sources of information, and should therefore not be used solely on its own to decide how you invest.
Stock market analysts, for example, often have biases because their livelihood depends on the companies who they are representing. So always consider why a broker may be talking up or talking down some stocks.
The best way to use an analyst’s recommendations is to do your own research first, and if you find an analyst’s recommendations who support your own findings, then there is a good chance that those stocks will perform well for you.
To help you become more analytical about analyst recommendations keep the following points in mind when listening to their advice:
Use an Analytical Approach
Stock market analysts use different approaches when analyzing the stock market, and sometimes, these approaches can produce very different results.
For example, some analysts look at a company’s current financial condition and their position in the industry and the stock market as a whole.
Other analysts look at how a company’s stock has performed over time, and then use that information as a predictor of how their stock will perform in the future.
The most accurate method is to use both of these approaches. When you do this research yourself, ask yourself if it supports or contradicts the analyst’s recommendations?
There is little point in listening to the recommendations of an analyst if everything they have said in the past has turned out to be incorrect. Listen to those who have a proven track record and dump the rest.
It is important to know how an analyst views a company’s performance. How do they look at sales and earnings? The company’s balance sheet? Debt?
Another important consideration is the industry a company is in. If a company is doing well, but the industry they are in is declining, then there is a good chance that their stock value will decrease in the foreseeable future. How much information does the analyst give you about this?
In order to analyze the stock market, an analyst needs to do research. You should be interested in what type of research they have done and what their sources of information are.
Some sources for example, may give misleading, inaccurate or biased information, which then affects the recommendation you receive from them.
If you are told that a stock is going to peak in value over the next coming months or years, be careful about following such a recommendation.
It is very difficult to predict how a stock is going to perform in the future, so you need to be confident that they have a good reason for giving you such advice.
Always look out for analysts who have ties to the company that they are recommending, as very often the information they give will turn out to be inaccurate.
Who Should You Invest With?
Any stockbroker who you choose to do business with should be registered with the National Association of Securities Dealers (NASD) and the Securities and Exchange Commission (SEC).
To protect your money after you have put it into a brokerage account, look for brokers who are also a member of the Securities Investor Protection Corporation (SIPC).
However, it is important to remember that this won’t protect you against market losses. It will only protect you if your brokerage firm goes out of business.
Personal vs. Institutional Brokers
Institutional brokers make their money from companies and institutions through investment banking, advisory services and other broker services.
Personal stockbrokers usually offer the same kinds of services, but they deal mainly with individuals and small businesses.
Reviewed – 29th March 2016