Best Online Brokers

Kiplinger's Personal Finance Magazine, Oct, 2001 by Brian P. Knestout, Erin Burt

TRADING | Our EXCLUSIVE RANKINGS, top to bottom--based on price and extra services.

WHAT'S EVERY online investor's top priority: low commissions or top-notch service? That's a trick question because the answer is both. You want a good price. And you want a broker with features and conveniences that match your needs. Luckily, online brokers seem to be heeding the call.

In this third annual survey of online brokerages, we rank them best to worst on both counts, price and services. For those who want a full range of services and amenities, Fidelity Brokerage ranks number one, even though its commissions are relatively high. A hairbreadth behind is Muriel Siebert & Co., offering a broad and inexpensive selection of no-load mutual funds. Charles Schwab & Co. ranks third, thanks to top-notch brokers, plentiful Web features and a good selection of funds.

But if you don't care for bells and whistles and just want inexpensive trades, Scottrade is tops. It offers cheap trades, smart phone representatives and a panoply of no-fee funds. National Discount Brokers, TD Waterhouse and Brown & Co. follow close behind (for the detailed rankings, see "Measuring the Online Brokers," below). Every investor, of course, has individual tastes, so before you choose a broker, visit a few of their Web sites and take them for a test drive.

To compile our rankings, we asked the 15 brokerages in our survey--which range from deep discounters to the online arms of full-service brokers--to answer an exhaustive list of questions. Only E*Trade declined to take part, but we obtained the necessary information on that brokerage from other sources.

We also opened individual accounts with each broker. Remember the Samsonite commercial in which a gorilla beats on the luggage? We subjected these accounts to various comparable stress tests. We placed trades, scoured Web sites for content and ease of use, and tested the knowledge of each firm's brokers.

Overall, we found that online brokers are performing very well--far better, on average, than they were only a year ago. The bear market has apparently inspired online brokerages to do more for their clients, who are trading much less frequently than they did. "Service expectations have never been higher," says Tracey Esherick, head of Fidelity's online brokerage.

Many brokers continue to offer inducements to open new accounts. For example, Ameritrade was recently offering 25 commission-free trades. Freebies, of course, dry up. But online brokers are also adding services to their Web sites, such as real-time updates of account balances. The industry is consolidating as well. In July, Ameritrade announced it would buy National Discount Brokers. NDB should continue to exist as a separate online brokerage after the merger--at least at first.

Commissions and fees

TO DIVIDE OUR brokers between no-frills businesses and those that provide more comprehensive services, we set an arbitrary dividing line of $20 per average stocktrade commission. Pay more and you should expect better services. Commissions are important because each dollar you spend on a broker is one less dollar to invest.

For ranking brokerages on commission, we averaged one market order for 2,000 shares at $10 each and one limit order for 100 shares at $50 each. Brown came out first, charging only $7.50, on average, followed by Scottrade and Datek, each of which charged $10 or less a trade. Most costly were Merrill Lynch, Morgan Stanley and Schwab, which each charged just under $45 a trade, on average.

We counted only commissions in ranking brokers on direct charges to customers. But beware that plunging earnings have led to more nuisance fees, especially among the brokers with the lowest nominal fees. For example, this summer Ameritrade began charging a fee for each trade confirmation it snail mails to customers, as did Datek and TD Waterhouse.

Inactivity fees, or fees for accounts with small balances, are coming into vogue, too. American Express, Ameritrade, Charles Schwab & Co., Datek, E*Trade and TD Waterhouse charge a fee if you have a small balance in your account or don't place enough trades that pay a commission within a specified period of time, usually six months.

How good a deal?

COMMISSIONS are only half the story when it comes to paying for stock trades. If you buy 500 shares of stock and the broker marks up the price by a nickel a share, that's $25 of lost investment potential, or double the commission at many online brokers. The good news this year is that brokers are doing a much fairer job of executing trades, perhaps due to harsh scrutiny of their execution practices by the media and the Securities and Exchange Commission. The changeover to decimal pricing of stocks may also have improved execution quality.

For our rankings, we asked brokerages how much they are paid for directing orders to market participants, the people who actually execute trades. The concern is that market participants may pay lots of money to a brokerage for the privilege of executing trades and then mark up the price of the stock to compensate themselves. You, the investor, pay in the form of higher prices on your trades.