Think of investing like moving to a new house. In a move, people need to get all of their belongings from one place to the next — with a variety of ways to do so. They can ask friends and family for help, do it on their own or hire a professional moving company.
Now, how a person decides to move is up to them, but the end goal is moving into a new home. Just like moving houses, investing in the stock market requires moving funds from one account to the market, and the investor has to choose by which means they’ll get there.
Some methods might mean more work on the investor’s end, and others leave it to the professionals.
In the investing world, stockbrokers are like professional movers in the above scenario. They’re professionally trained, with plenty of moves under their belt. Their experience can make them a valuable resource, as they know how to move that box of dishes without breaking a single one.
Why investors use a stockbroker
No one says a person has to use professionals to move successfully, but for some, they can provide a sense of relief. Now, stockbrokers aren’t going to move a person’s couch down three flights of stairs in the middle of the summer, but they will provide them with a plethora of investment services:
• They’ll trade securities for their clients, and usually earn a commission off of each trade.
• Stockbrokers who are also financial advisors may dispense trading advice based on their experience with the stock exchange and education.
• Give their clients additional tips and suggestions, like what investments they should buy and sell.
The day to day dealings of a stockbroker are not dissimilar to sales. Their salary is largely dependent on commissions, which means they’ve got to be pretty good at what they do to make a living.
Working with a stockbroker can mean building a human relationship within a person’s investment strategy. This way there is someone available to discuss ideas and strategies, and investors can benefit from a stockbroker’s experience.
This isn’t taking a hot investment tip from an uncle or someone at the grocery store–stockbrokers have to pass several licensing exams and work with a registered firm.
That being said, for most stockbrokers, their payment comes from your trades, which means a client has to pay their stockbroker every time they buy, sell and trade.
For some, the knowledge of a stockbroker is worth the cost of doing business. For others, the idea of DIY-investing is more appealing. It all depends on personal preference–does a person want to move on their own, or pay someone else to do it?
Full service vs. online brokers
Before the development of online brokers, it used to pretty much be a one-horse town when it came to investing. Pre-1970s, if a person wanted to put their money in the market, they had to work with a full-service broker (like those described above), and likely had a relationship with them as they managed a chunk of the investor’s finances.
The world of investing started to change in the 70s with Charles Schwab. Now a big name in investing, it was the first to offer discount trades in the world of investing.
At the same time, technology was becoming a bigger part of life on the trading floor. Brokers started using computers and software instead of landlines and phone calls to execute trades.
As technology evolved, so too did the nature of investing. The development of Electronic Communication Networks (ECNs) and the expansion of the internet into our day to day lives made it easier for anyone to trade.
Now, fast forward to today, and people can quickly and affordably invest on their phone through an app with the tap of a few buttons, no stockbroker required. So how do the online brokers of today differ from the experience with a full-service brokerage?
• The investor is in control. With an online broker, the investor is the one deciding what to buy and sell. They don’t have a stockbroker telling them what to do, meaning they can make trades at the drop of a hat. This is helpful for buyers who like to keep an eye on their investments and enjoy making frequent changes and tweaks to their portfolio.
• Investors don’t need much money to get started. With online brokers, investors need as little as a $1 to get started, and they can trade for free or little charge, unlike traditional brokerages where each transaction will cost the investor. Additionally, many online brokers allow people to invest in fractional shares, where a person needs to only buy a portion of a stock instead of the whole thing.
• The investment tool is in the palm of an investor’s hand. Online brokers of today have simple to use apps where a person can trade anywhere they can take their phone. This is dramatically different from the full-service brokers, where someone might need to call to execute a trade.
• Investors can have a diverse strategy. Most online brokers have a variety of accounts to open available through their services. Someone can invest in ETFs, stocks, bonds and more, depending on their offerings.
• The investor has to do their own research. Online brokers make it cheaper, easier, and faster to invest, but that comes with the tradeoff of more legwork on your end. An investor won’t have a dedicated person working on their account like a full-service firm, so it’s up to them to research and decide which investments are ultimately best for them.
• Investors are on their own. If a person is using an online broker, chances are they won’t have much human interaction. It’s unlikely there’s an office to visit, or even a specific individual to call if they have questions. This is one of the ways online traders keep costs down, but it does keep an investor from working with humans.
To circle back to the moving metaphor, a person deciding to move on their own is like using an online broker. An independent move means doing all of the packing and moving items from one place to the next.
The person moving is in control of every aspect of the move. They get to decide, through their own research and legwork, what method of moving works best for them.
Buying stocks solo
How can a person pull a DIY and buy stocks on their own? There are a couple of routes they can take. Read on to learn about different investment strategies.
Direct stock purchase plans
Direct Stock Purchase Plans (DSPPs), let people go straight to the source to directly invest in a company that’s publicly traded. That means an investor wouldn’t need to use a broker, traditional or online, at all in the transaction.
Not all publicly traded companies offer DSPPs, but some companies that do include well-known names like Walmart, Clorox or McDonald’s.
Buying DSPPs comes with its own unique set of advantages:
• Passive investing. Many DSPPs plans allow an investor to set it and forget it—meaning they can invest a set amount on some kind of recurring basis.
• Lower fees. DSPPs often charge little or no commissions or fees once the account is set up.
• An investor might get a discount. Depending on the company a person invests in, they might be offered a slight discount, between 1% and 10%, for investing directly.
While DSPPs have benefits, there are some drawbacks as well:
• Higher upfront costs. While the DSPPs usually don’t charge commissions or fees, there can be a cost associated with starting the account. DSPPs oftentimes require a $250 to $500 initial investment and they don’t permit the purchasing of fractional shares.
• It’s another account. DSPPs are held with individual corporations. Investors can’t consolidate your DSPP holdings into a single account because they all live on each company’s individual platform.
• They’re typically long-term investments. DSPPs don’t offer the same flexibility and speed of an online broker. For that reason, they’re typically considered more appropriate for a long term investment.
Investing in a DSPP is going straight to the source for a long term investment. While it’s not for everyone, some investors will find a benefit from the setup.
Dividend reinvestment plans
Dividend Reinvestment Plans (DRiPs), share many similarities to DSPPs— some DSPPs offer DRiP programs. Investors are still buying stock directly from the publicly traded company, but a DRiP allows them to reinvest the dividends earned on the stock directly back into the company to purchase additional stock.
So, instead of quarterly cash payouts, that cash is reinvested. DRiPs are not always offered with DSPPs, because some companies don’t pay out dividends on a regular basis.
In addition to the benefits of DSPPs, DRiPs have a few to offer on their own:
• It’s automated, compounded growth. Reinvesting dividends is not dissimilar to compound interest. DRiPs allow investors to continually reinvest and grow, without having to add funds.
• Fee-free reinvestment, even in fractional shares. Investing the dividends comes fee-free. Investors are also usually offered the opportunity to buy fractions of a share.
DRiPs share many of the same drawbacks as DSPPs, but also have a few specific to them:
• Limited selection. Not all companies that offer DSPPs offer DRiPs, which means you’re selecting from a smaller pool.
• Dividends are still taxable. Although the cash is automatically reinvested in a DRiP, investors will still be taxed on the gains. That means they’ll need to have liquidity elsewhere to pay the tax.
DRiPs, while they share DNA with DSPPs, are a strategy all on their own. Depending on individual financial circumstances, they could be a worthwhile option.
Online brokerage accounts
If online brokerage accounts were a restaurant, they’d have counter service. An investor places an order and the brokerage fills it. That means an investor saves on the cost of service, but loses the opportunity for table service or, in this case, the full services offered by a traditional brokerage.
After opening an account with an online brokerage, what an investor does with it next is up to them. They tell their broker what they want to buy, and how much of it, and then the broker completes the order.
Depending on the online broker, there may be low or no fees associated with making a trade. It might sound pretty easy, but online investing has its own share of pros and cons. Here are a few of the advantages:
• Low fees. When it comes to online investing, people can typically expect to pay lower fees. Recently, many online firms have even eliminated commissions.
• DIY investing. There’s a lot of freedom that can come with an online brokerage account. An investor gets to choose, creating a customized plan.
• It’s on-demand. As long as the markets are open, an investor can ask for trades through their e-investor.
Of course, with all the benefits come a few drawbacks:
• It’s all on the investor. Online brokerages don’t often offer the services that would be available with a full-service broker. Online investing can give investors a lot of choice and freedom, but without the expertise of qualified financial professionals, some investors might be left to research and form a strategy on their own. For some, this might feel stressful.
• It’s for the long term. Since online investing is on-demand, a person can sell whenever they like. That can be a challenge for an investor if patience isn’t their strong suit.
Online brokerage accounts have come a long way, and they’ve helped to remove some of the barriers preventing people from investing. However, they’re not for everyone.
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