What is Investment Brokerage?

Investment brokerage involves buying and selling investments like stocks, bonds, mutual funds, and other securities on behalf of clients. Investment brokers serve as intermediaries between buyers and sellers in the financial markets.

In this complete guide, we will cover:

Outline:

• What is Investment Brokerage?

• Services Provided by Investment Brokers

• Types of Investment Brokers

• Full-Service Brokers
• Discount Brokers
• Robo-Advisors

• Brokerage Accounts

• Fees and Commissions

• Choosing an Investment Broker

• Pros and Cons of Using a Broker

• Broker Regulation and Insurance

• Frequently Asked Questions

• Key Takeaways

What is Investment Brokerage?

An investment brokerage firm facilitates the trading of securities between buyers and sellers. The critical role of a broker is to take orders from clients to buy or sell investments and execute those orders through financial markets.

When a client wants to purchase a stock or exchange-traded fund (ETF), the broker will source the security on their behalf and charge a commission or fee for providing this service. The broker may either fill the order directly from its inventory (acting as a dealer) or seek to match the order with other interested buyers and sellers.

Similarly, when a client wants to sell a security, the brokerage will handle advertising the availability of the protection for sale, collecting payment from buyers, and delivering the funds minus fees and commissions to the client seller.

In addition to the essential execution of trades, full-service brokers often provide services like financial planning, retirement planning, portfolio management, and more.

Overall, the critical functions of an investment broker include:

• Taking client orders to buy and sell securities

• Sourcing securities to fill buy orders

• Matching securities sales with interested buyers

• Facilitating the exchange of funds between parties

• Providing investment recommendations and planning

• Managing client portfolios and accounts

• Providing market research and analytics

By serving as an intermediary, investment brokers aim to provide efficient execution and access to securities markets in return for brokerage fees charged on transactions.

Services Provided by Investment Brokers

Investment brokers offer clients various services depending on the firm type and account offerings. Major services include:

• Trade Execution - The core function of brokers is executing securities trades placed by clients. That may involve tapping the firm's inventory or sourcing the securities from other traders.

• Access to Products - Brokers offer access to various investment products, including stocks, bonds, mutual funds, ETFs, options, futures, and more. Availability varies by broker.

• Investment Guidance - Full-service brokers guide investing strategy and recommendations through human advisors. Some firms also offer robo-advisors.

• Portfolio Management - Many brokers help design, manage, and rebalance portfolios based on client investment goals. That includes handling trades and ongoing monitoring.

• Financial Planning - Full-service brokers may assist with broader financial planning for goals like retirement or college savings based on risk tolerance.

• Research - Brokerages produce reports, earnings estimates, and other market data to inform investment decisions.

• Tax Reporting - Brokers handle tax documentation reporting, like 1099 forms for investment income.

• Custody - Brokerages hold the securities clients purchase in street names and provide account statements.

The range of services depends on the brokerage model (full-service, discount, robo-advisor, etc). Individual investors can select a firm that provides the level of service needed.

Types of Investment Brokers

Several main types of investment brokers provide varying levels of service and advice at different price points. The major categories include:

Full-Service Brokers

Full-service brokers offer personalized advice, active account management, and extensive customer service. They employ human financial advisors who provide recommendations across various investment products, including stocks, bonds, mutual funds, ETFs, etc. Full-service brokers tend to have high fees and account minimums but are a good option for investors who want professional management.

Examples of full-service brokers include Merrill Lynch, Morgan Stanley, Wells Fargo, and Edward Jones.

Discount Brokers

Discount brokers focus on providing discounted commissions and fees for the execution and processing of securities trades. They allow clients to make their own investment decisions through online trading platforms. Discount brokers have limited advice and account services compared to full-service firms but significantly lower fees. Many leading discount platforms also offer educational resources.

Examples include Charles Schwab, E*Trade, TD Ameritrade, Fidelity, and Interactive Brokers.

Robo-Advisors

Robo-advisors provide automated investment management using algorithms and little to no human intervention. Investors offer details on their financial goals, time horizon, and risk tolerance which the robo-advisor uses to select and manage a suitable portfolio, typically comprised of ETFs. Fees tend to be low, but the products and services are limited compared to human advisors.

Examples include Wealth front, Betterment, Ellevest, and SoFi.

Online Brokers

Online brokers conduct brokerage services digitally through websites and mobile apps. They emphasize self-directed trading and research. While execution and processing happen online, many can access human assistance via phone or chat. Fees are low, but the investment choice is more limited than full-service brokers.

Examples include E*TRADE, Merrill Edge, and Vanguard.

Brokerage Accounts

Investment brokers provide customers access to different account types for their investing needs:

• Cash Account - A standard account for buying and selling securities funded with cash. Trades settle in 2 days.

• Margin Account - Allows leveraged trading borrowing funds from the broker. More risk but increased buying power.

• IRA Account - Tax-advantaged retirement account with options like Roth, Traditional, SEP, and more.

• Trust Account - Special arrangement to manage assets for trusts and estates.

• Joint Account - Account shared and co-owned by two or more people.

• Custodial Account - Brokerage account opened by an adult for a minor.

• Education Savings Account - Tax-advantaged account to save for education like a 529.

Brokers can advise selecting the appropriate account type based on an investor's goals and needs.

Fees and Commissions

Investment brokers generate revenue through fee and commission structures, including:

• Trading Commissions - Fees charged per trade, often per stock or contract. Ranges from $0 to $10+.

• Account Maintenance Fees - Annual or monthly fees for administration and account access.

• Account Minimums - Minimum account balance required to open/maintain an account.

• Management Expense Ratios - Annual fee for managed portfolios or mutual funds.

• Inactivity Fees - Charged if accounts are dormant for periods.

• Transfer Fees - Fees for transferring assets in or out of the report.

• Other Transaction Fees - Miscellaneous fees on wires, ACAT transfers, etc.

Fee schedules vary widely across investment brokerages, from zero-commission models to traditional fee structures. Investors should consider the cost and the services provided when choosing a broker. Disclosure documents outline all fee details.

Choosing an Investment Broker

Here are some key factors to evaluate when selecting an investment broker:

• Services - Consider the level of advisory services and account management needed. Compare full-service, discount, robo, and online brokers.

• Fees - Compare commission schedules, account fees, and any minimums across brokers.

• Range of Products - Determine if the broker provides access to required investments like stocks, mutual funds, and ETFs.

• Reputation & Reviews - Research broker reputation and reviews from independent sources like Investopedia or NerdWallet.

• Tools & Resources - Compare trading platforms, research capabilities, and educational resources.

• Ease of Use - Open demo accounts to test account opening, funding, trading, and customer service.

• Regulatory Compliance - Ensure the broker is registered and compliant with SEC and FINRA regulations.

Matching a broker to individual needs, preferences, and investment style is critical to a positive experience.

Pros and Cons of Using an Investment Broker

Pros

• Market Access - Convenient access to securities markets like stocks, bonds, and derivatives.

• Trade Execution - Expertise executing trades through financial markets.

• Account Services - Custody, reporting, transfers, and other account administration.

• Unbiased Advice - Full-service brokers may provide impartial investment guidance.

• Portfolio Management - Rebalancing and monitoring of managed portfolios.

• Convenience - Brokers handle all paperwork and processes of investing.

Cons

• Costs - Account fees, commissions, and other brokerage costs.

• Conflicts of Interest - Incentives to push proprietary products or high-commission trades.

• Account Minimums - Full-service brokers often have large minimum account sizes.

• Limited Products - Many brokers have a restricted list of tradeable securities.

• Tax Implications - Short-term trading driven by brokers can result in taxable gains.

• Bias - Firm incentives over client needs may guide brokers.

As with most financial services, both advantages and drawbacks are inherent to using an investment broker for trading and advisory services. Investors should weigh the costs against the benefits.

Broker Regulation and Insurance

The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) regulate investment brokers in the United States.

The SEC crafts rules and conducts exams of broker-dealers to protect investors. FINRA registers and monitors brokerage firms for compliance.

Brokers are also required to carry insurance coverage:

• SIPC Coverage - Protects client assets up to $500,000 against broker insolvency.

• Additional Insurance - Many large brokers take other private policies for asset protection.

While brokers undergo routine auditing and oversight, investors should still research the broker's reputation and confirm regulatory registration before opening an account.

Frequently Asked Questions

What do investment brokers do?

Investment brokers act as intermediaries between buyers and sellers of securities like stocks, bonds, and derivatives. Essential functions include executing client trades and providing access to investing products, markets, and services for a fee.

What are the main types of investment brokers?

The four primary types are full-service brokers, discount brokers, robo-advisors, and online brokers. They vary in services from personalized advice to self-directed trading.

How do investment brokers make money?

Brokers earn revenue through account fees, commissions, management expense ratios, and other service charges clients pay. The fee structure varies across broker types.

What are the benefits of using an investment broker?

Significant benefits include convenient market access, trade execution expertise, account services, portfolio management, financial planning, and unbiased advice in some cases.

What are the downsides of using an investment broker?

Downsides can include:

• Higher costs.

• Account minimums.

• Potential conflicts of interest.

• Bias towards profit over clients.

• Tax implications of excessive trading driven by a broker.

How are investment brokers regulated?

Investment brokers must register with the SEC and FINRA, which craft rules and monitor for compliance. Brokers also carry insurance like SIPC.

Key Takeaways

• Investment brokers are intermediaries that execute securities trades and provide related services to clients for a fee.

• Primary brokerage services include trade execution, investment recommendations, portfolio management, and access to products like stocks and mutual funds.

• The main types of brokers include full-service, discount, robo-advisors, and online, which range from personalized to self-directed.

• Essential broker fees include commissions, account fees, management expense ratios, and account minimums that investors should evaluate.

• The benefits of brokers include market access, account services, and advice, but customers must weigh costs and potential conflicts of interest.

• Investment brokers are regulated by the SEC and FINRA and carry mandated insurance policies to protect clients.