If you’re new to investing, you might be wondering, what does a broker do? And do you really need one?
The term “broker” is often used to describe not just the person that may help you buy and sell securities but the actual firm itself. When viewed using that broader definition, brokers are absolutely essential for processing trades. But it’s important to know what type of broker is best for you and to understand the types of services brokers provide.
Read on to understand how to define broker so you can choose the best broker for your investments.
What Is a Stockbroker?
A financial broker is an intermediary that is authorized to sell and purchase securities and stocks on behalf of buyers and sellers. Brokers provide various investment services on behalf of their clients, usually on commission. However, different brokers charge different fees for brokerage services. For example, some brokers might charge an annual fee of 1% or more of your assets in lieu of commissions, while others might charge flat fees for services such as estate planning. Some online brokers now charge $0 commission for most trades of equities and exchange-traded funds.
What Is a Brokerage?
A brokerage is an institution that processes your securities transactions. Whether you trade with a traditional full-service firm like UBS or Merrill Lynch or use an online platform like Robinhood or E-Trade, you’re dealing with a brokerage.
How To Become a Broker
In order to become stockbrokers, individuals must pass the General Securities Representative Qualification Examination, also called the Series 7 Exam. They will then be authorized to trade stock on the stock exchange.
Types of Stockbrokers
If you are a beginning investor, the first step to building your investment portfolio will be choosing a broker and opening a brokerage account. Of the types of services stockbrokers offer, they generally fall into one of the following three categories:
- Execution-only, in which the broker only executes the buyer’s instructions to buy or sell.
- Advisory, in which the broker advises the client on what the best trades are, but leaves the decision up to the investor.
- Discretionary, in which the investor empowers the stockbroker to make deals at the broker’s own discretion, with an understanding of the investor’s ultimate investment objectives.
Execution-only stockbrokers do not provide clients with advice about the pros or risks of a certain investment; they merely act as an intermediary to buy and sell at the client’s request. These type of stockbrokers typically offer their services online. They are best suited for people who have enough knowledge of the stock market to make decisions without needing outside counseling.
Execution-only stockbrokers typically have low fees, often charging $0 for standard equity and ETF trades. This is the prime advantage of using this type of broker.
With an advisory broker, there is an open dialogue between the client and the broker. The client can ask the broker for advice when deciding whether or not to buy or sell a stock, and the broker can contact the client as well to suggest they consider buying or selling a certain stock.
Advisory stockbrokers are a good choice for people who want to be hands-on about their investment choices but who feel more comfortable dealing with a professional for added insight. Advisory brokers typically charge a fee for their services, which may come in the form of asset-based fees, flat pricing or commissions.
For those who favor a more hands-off approach to investing, a discretionary stockbroker could be the better choice. With a discretionary broker, a client will discuss their investing goals, overall portfolio, risk tolerance and other parameters with the broker upfront. Then, it’s up to the broker to decide when to buy and sell to conform to the expectations the client has set. This type of arrangement requires a lot of trust in the broker you select.
Traditional vs. Discount Broker Definition
Traditional brokers generally offer advice to clients, and in some cases they may also handle discretionary trades. These types of brokers tend to have a one-on-one relationship with their clients.
Discount brokers, or online brokers, tend to be execution-only. Online brokers have dramatically gained in popularity over the past decade or so.
One of the biggest differences between traditional and discount brokers are the fees. Because traditional brokers offer one-on-one services, the fees are much higher than with discount brokers, which tend to have low fees.
Most traditional and online brokers offer both standard and extended-hours trading. However, with an online broker, you may be able to enter your trades after-hours so they are queued up and ready to go as soon as the market opens. With a traditional broker, you’ll have to wait until he or she arrives in the office and is able to process your trade on your behalf.
Traditional brokers typically provide assistance and advice for clients, but discount brokers usually do not. People who would like a personal relationship with their broker, or who could benefit from their expert input, should opt for a traditional broker.
How To Choose a Broker
Before you commit to opening an account with one broker or another, you should do your research and compare the options available to you. Start by asking yourself what sort of benefits and services you are going to use, and how you are planning to invest. Although cost shouldn’t be your only consideration in choosing a broker, it’s also an important factor, as you should be sure you’re receiving value in exchange for any fees that you pay. Ultimately, choosing the right broker might be the best investment you could make.
Information is accurate as of June 14, 2022.