The 13 Steps to Investing Foolishly
Step 6: Open a Discount Brokerage Account

Full-Service Brokers

Full-service broker is the name given to those expensively dressed souls who work for Merrill Lynch, Salomon Smith Barney, Morgan Stanley Dean Witter, etc. The phrase "full-service" indicates that they are there to attend to ALL the needs of their account holders. That includes generating investment ideas for you, giving you stock quotes whenever you request them, managing your account (in many cases), providing investment research materials, helping you with tax information -- the works.

In return for these full services, the broker will charge you very high rates to trade stocks in your account. Whereas discount brokers (we'll get to them in a second) typically charge between $5 and $20 for an online trade, you'll probably pay around $150 for the average trade done through the typical full-service broker. Furthermore, full-service firms often charge annual "maintenance" fees through which they grant themselves a generous slice of your assets, say about $150 a year or more. In other words, they provide an expensive "service."

OK, two problems here. (Actually, dozens of problems, but we'll keep it to a brief two for now.)

The first is that most brokers (or, more snootily, "Financial Consultants") who give advice are just glorified salesmen, shopping around their brokerage house's stock picks or pricey mutual funds. While there are some knowledgeable brokers who do a knockout job for their clients, many aren't actually very good investors and lack impressive or even average performance histories.

The second problem is that full-service brokers usually receive commissions on each trade, so their compensation is closely tied with how often their clients' accounts are traded. The more trades you make, the more money they make. Highly distressing.

The full-service industry will save itself only when it bases its incentives on performance, not trading frequency. Your broker should be working to give you the best consistent long-term, market-beating return possible, and should receive bonuses based on a percentage of your long-term profits.

Discount Brokers

Discount brokers provide a more affordable means for investors to execute their trades. Discount brokers are for do-it-yourself investors. The idea of paying exorbitant fees to some full-price broker for sub-par returns makes little sense. But just as you need to go out and select tools and materials before you can begin to fix things around your house, you need to learn a little before you go out and pick a brokerage.

There are lots of discount brokers. We've set up a Discount Brokerage Resource Center to help you figure out how to select one. There we've included a comparison tool to allow you to compare our sponsor brokerages, side by side. And you'll find answers to commonly asked questions, such as:

• How do I open an account?
• What if I can only invest small amounts of money?
• Can I transfer my current account to a new firm?
• What's the difference between a cash account and a margin account?
• Can I buy mutual funds through a discount broker?
• Is online trading secure?

We also have a Discount Broker discussion board, which features the Foolish community providing the best answers anywhere on choosing the right discount broker for your needs.

Here are 10 things to think about as you begin your search:

1. Read the fine print. Keep in mind that there are virtually always going to be hidden costs, from account minimum balances, to fees for late payments or bounced checks, to transaction and postage and handling fees.
2. Commission schedules can vary considerably within the same brokerage, depending on the trade. If you most typically buy 1000 shares of stock below $10 a share, use this trade as a test of your prospective brokers. See how much of a commission you'd pay for your typical trade with each prospective brokerage.
3. If you want to trade foreign stocks or options or penny stocks, none of which we generally counsel doing, make sure your discounter is set up to trade them.
4. Check out the margin interest rate, if you plan on ever borrowing money from your broker for purchases. Margin rates vary substantially from broker to broker. If you're Foolish, you won't want to even think about using margin until you've been buying and selling your own stocks for a couple of years. (For more on margin, see Step 12, Advanced Investing Issues.)
5. The availability of checking accounts or bill paying may be very attractive to some. Discount brokers are expanding their banking services in an attempt to make the most from each customer. Do you really still need a checking account from a separate bank? A lot of Fools don't.
6. Mutual funds: You probably know already that we're not big fans of the world of underperforming mutual funds, but, heck, maybe you disagree with us. If so, and you're looking to buy mutual funds, learn which funds are offered from any prospective discount brokers.
7. Research and investing tools: We have plenty of free research and heaps of investing tools available right here at Fool.com, but one of the perks of a brokerage account is (or should be) getting access to additional screening tools, analyst research reports, stock charts, and more.
8. Money market sweeps: Does your prospective brokerage sweep any unused funds into a money market account at the end of the day? Check into it.
9. Touch-tone (phone) trading and/or a local office: If you want to place a trade the old-fashioned way -- through automated touch-tone dialing or by phoning a human broker -- see if that's offered. If you want a real bricks-and-mortar office, find out if there's one near you.
10. Free perks are free perks. Some are even worth having. Whether you're talking frequent flyer miles, free trades on your birthday, or even cold hard cash placed right into your account, there are some things out there that could tip the balance in favor of choosing one discounter over another.

What do you do once you've chosen a discount broker and are ready to pick your first stocks? Move on to Step 7 to consider some Dow heavyweights.

Next Step: Dow Approach »

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