Saturday, June 20, 2009

How to choose a broker?

The broker is the second most important person in your investing life. The first one is you of course. So what is the broker? He can be described as an intermediate between you and the market. You will use him to buy the different instruments on the market. Even though you can buy some instruments on your own, it is time consuming and you might not have access to a wide range of investment instruments as you would if you have a broker. so for all practical purpose i will advise anyone to invest through a broker.

What are the different type of brokers?

There are mainly three types of brokers:

1. Full-service broker

A full-service brokerage as the name suggest will provide all the services that one can need. The broker will provide you with a wide range of securities, they would provide recommendations and advices on the securities that you can buy. The broker can also tailor-make a portfolio for you that is appropriate for your situation. This type of broker is ideal for if you are new to investing because it will reduce the risk that you can commit a costly mistake. This type of broker is generally costly but it is worthwhile for you until you are able to invest on your own. You will pay the broker a fee for advices and a commission as a percentage of transactions.

2. Discount broker
The discount broker will give you access to investments instruments but will not give you advices or give you information, He will only take your instruction on what to buy and what to sell. Your instructions will be through fax, email or telephone. You will have to use your own experience, researches and knowledge on what instruments to buy and to sell. Normally an investor will start with a full-service broker and the later on move to a discount broker. This type of broker is usually advised for experienced investors. This type of broker take a small commission and as a result is better for those that want to increase return.

However if you want to be a couch potato investor and invest in bond fund, index funds, etc it is better to use a discount broker.

3. Online broker
The advent of the internet has come blurred the distinction between the two types of brokers. Now both traditional discount broker and full-service broker are offering online services to cater for the investors that want do things for themselves and who want to have access to real-time information. However it is increasingly common for discount broker to offer online research reducing further the difference between an online broker and a full-service broker. The online broker is the cheapest of all and as a result it is advisable for someone who can manage his investment by himself and who need access to the latest information.

Factors in choosing a broker

1. Make sure that the broker is a registered broker. It must have a good reputation. You can do this by talking around with friends, colleagues and making your own research. The broker must also have a good reputation in the financial world. Only after this has been done that you can go forward. I choose the brokerage arm of my bank.

2. Your financial goals, If you have goals such as retiring, sending your children to school, etc then it is better to choose someone that can give you advice. He will advise you on the portfolio composition, what instruments to buy and sell and what investment strategies to adopt. Then a full-service broker is advised.

3. Your risk tolerance. If you have a low risk tolerance then you will be scared to make mistakes and lose your investment. Then a discount broker is not for you. It would be better if someone else do all the work and take the important decisions for you. Read this post on risk and risk tolerance.

4. The fees and commissions charged by the broker. Remember on the long run fees and commissions reduce your return, so it is important to choose a broker that offer the lowest rate. Discount broker generally offer the smallest rate.
Read this post on fees and commissions on your portfolio.

The brokerage account:

There are two types of brokerage account

1.The cash account

The cash account is like a regular account. You deposit money in it. when you give the broker an instruction to buy a security, the broker will use the money in the account. You can buy securities worth not more than the amount of money in the account. Note also that the dividends that you receive from companies will be deposited in the account.

2. The margin account

The margin account is like a credit account that the brokerage give you to buy securities. When you buy a security you will have to pay the money back with interest. This type of brokerage account is recommended only for the experienced investor. Those involved in option trading or similar risky transactions. I would strongly advised the average investor to invest using a cash brokerage account.

3. Option account

This type of account is for those who want to trade in options. Remember that option trading is very risky. Please read this article to understand risk. I would recommend this type of trading for the experienced investors only.

Please read the second part of this post here.

How to start investing with a small amount of money?
Fees and commissions and how they affect your portfolio.
What is a stock?
How to be rich buying stocks!!
what is a stock exchange?
What is market capitalisation?

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