Time to Choose a New Broker? - Part II

February 2, 2005

Last month we shared the unfortunate news that Scottrade is raising their mutual fund buying fees. This month we will go into greater detail about the alternatives to Scottrade. 

All of the funds in our model portfolios that are currently open to new investors are available at Scottrade. Of those, about half (44%) are still available for no transaction fee. The other funds will require paying $17 to buy or sell, with an extra $17 penalty if you trade out within 180 days of purchase. We rarely sell within 180 days, so this extra charge is not a deal breaker for us (although new subscribers should take note because we may sell a holding we have owned for over a year that a new subscriber just bought two months ago).

It is worth noting that Scottrade does not have the nicest website in the land. Their customer service is about average, to slightly above average. It is fairly easy to get a live person on the line because they have branch offices all over the country, which usually ensures a good response rate.

As for the alternatives, discount brokers tend to fall into two camps: regular and "deep discount". Schwab is a discount broker because it is cheaper than a full service broker like Merril Lynch to buy and sell stocks. Deep discount brokers like Scottrade are cheaper than most discounters, but often with fewer bells and whistles. 

The deep discounters we track include Scottrade, E*Trade, BrownCo (the old Brown & Company), and Ameritrade. Here's a rundown on those.

<b>E*Trade</b> offers a slick website but (in our experience) terrible customer service. If the market is open, good luck getting a live agent on the phone within 15 minutes of your call. That said, they have a very good fee structure. Like the new Scottrade fee structure, E*Trade charges a commission to buy non-NTF funds. At E*Trade this fee is $24.95 - higher than Scottrade by eight bucks. However, E*Trade recently launched a 12b-1 fee kickback program where they rebate half the fees the funds pay brokers behind the table back to their own customers. 

This is a pretty sweet deal. Because of this kickback it is now cheaper to buy certain funds from E*Trade than through the fund family directly.

E*Trade's website <a href="https://us.etrade.com/e/t/invest/mfrebatelist" target=new>lists the funds that pay these kickbacks</a>, and what an investor's cut will be (). SSgA Emerging Markets is in our aggressive growth and daredevil model portfolios. It has been on a good run for investors, in 2004 up 24.7% (not bad following a 54% return in 2003). But investors who buy the fund through E*Trade not only get to buy for free, they get a 12.5 basis point (.125%) kickback each year. On a $10,000 investment this works out to $12.50 a year. Not bad considering the fund is one of the cheapest in the category.

Our typical model portfolio has two funds that are paying E*Trade enough to warrant kickback to E*Trade customers. Our moderate portfolio has nine fund holdings, three pay E*Trade: Jensen (JENSX), Forward International Small Company (PISRX), and Bridgeway Balanced (BRBPX). The kickbacks are 17.5, 10, and 7.5 basis points respectively, or $1.75, $1.00, and $0.75 per year per $1,000 invested. Through all of our model portfolios, there are 15 cases of 12b-1 rebates. For large investors these kickbacks can be quite large. Since the $24.95 fee is a small percentage of a big trade, investors with large account balances should consider E*Trade - the kickbacks increase with trade size, the $24.95 remains fixed.

Unfortunately, four of our moderate portfolio funds require paying $24.95 to buy and sell (all from Vanguard). Even worse, one of the nine funds in our moderate portfolio is available at E*Trade at all. So while the rebates could easily make up for the $8 more per trade that E*Trade charges (over Scottrade's fees for non-NTF funds), fund availability can be a problem. 

Currently you would have no problems building Low Minimum and Daredevil portfolios at E*Trade. The other portfolios each have one, and sometimes two funds that are not available at all at E*Trade. We may offer some alternatives for non-E*Trade funds soon, as their 12b-1 fee kickback program is innovative enough for us to support.  

<b>Ameritrade</b> is primarily for stock investors, but they have many funds available (in fact, Ameritrade offers more funds than any other deep discounter). Too bad they do not have any funds NTF - all buys and sells require paying a fee for regular accounts. The commission for each buy and sell is $17.99 - just barely above Scottrade. On the plus side, there is no extra fee for selling after a short holding period, other than the fees the fund itself may charge. All of our model portfolio funds are available at Ameritrade, but all require paying a commission, unlike Scottrade or most every other broker, where at least some funds are NTF.

<b>BrownCo</b> (formerly Brown & Company) is looking like a very good second choice - if not a very good first choice - for some. They have many NTF funds, and their non-NTF funds are just $5 ($12 less per trade than Scottrade). The only problem is that BrownCo "may charge a short-term trading fee of $75 each time you sell or exchange any shares of no transaction fee (NTF) funds held less than 180 calendar days (short-term trade) from purchase date." From our calls to BrownCo it seems very likely they will levy this charge.

Since we don't trade frequently, this extra fee would be rare for longer term subscribers. This fee was added to punish fund timers, which is ironic because JP Morgan Chase, a company that now owns BrownCO, was itself wrapped up in the fund timing scandal. 

BrownCo says that they require "experienced investors" to open a new account (how they audit this is a mystery). BrownCo requires at least five years of investment experience, a net income of at least $40,000 a year, a net worth of more than $50,000, and all new accounts must be funded with a minimum of $15,000 in cash. Scottrade requires a pulse, a social security number, and $500. This is one reason some may want to avoid BrownCo. Currently you can buy all of our funds at BrownCo, and we intend to maintain compatibility with this broker going forward.

<b>Muriel Siebert</b> is not a bad choice, but they require a higher minimum than most funds charge to get in for NTF. If you don't pony up $5,000, you'll get slapped with the non-NTF commissions of $35.00 (although this is a one time fee). While all of our funds are currently available at Siebert (they have a long list), only about a quarter are NTF. 

The high fees and too few NTF choices are almost a deal breaker here. The one upside is that investor's can get on an auto-investing plan that invests in several funds at once at no extra charge. Because of commission fees, making repeat small investments can be costly for fund investors buying non-NTF (or TF) funds at a brokerage platform. For this, reason those looking to invest in regular small increments generally have to go directly through a fund company's auto-investing plan.

The Big Three. The major discount brokers for fund buyers are <b>Schwab</b>, <b>TD Waterhouse</b>, and <b>Fidelity</b>. All have excellent websites, a large number of funds available, and acceptable customer service. Unfortunately, they are all quite expensive if you buy non-NTF funds like Vanguard or Dodge & Cox. 

All of our model portfolio funds are available at all three except 1) Low Minimum holding SSgA MSCI EAFE Index (SSMSX) is not available at TD Waterhouse 2) Daredevil and Aggressive Growth holding SSgA Emerging Markets (SSEMX) is not available at Schwab.

The trouble with these big brokers is not the size of the fund platform or the amount of NTF funds, but rather how much they charge to buy a non-NTF (or transaction fee, or TF) fund. 

About 30% of our portfolio funds (depending on portfolio) are available for NTF purchase at the big three (the rest require paying a fee). TD Waterhouse has the most NTF funds, Fidelity the least, Schwab just a bit more than Fidelity.

At TD Waterhouse the online commission for TF funds ranges from $30 - $75 per buy and sell, with a $24 - $75 short term redemption fee if you sell within 90 days. Note that TD will not charge the short term redemption fee if a fund charges one. 

At Schwab the online commission for TF funds ranges from $49.95 - $164.95 for each buy and sell. It is worth noting that Schwab can charge 2% of the transaction for any NTF funds sold within 180 days of purchase (in addition to any fund level short term redemption fees). 

At Fidelity the online commission for TF funds is $75 per buy and sell. Fidelity charges a $75 short term redemption fee if investors sell any NTF fund within 180 days of purchase.

Of the big three, we like TD Waterhouse the best. If they didn't raise their fees a few years ago to be more in line with Schwab and Fidelity, we would choose them as our #1 broker. At least 80% of those who buy no load funds at a broker use one of these three.

With all of the brokers mentioned above, we considered their lower online commissions only; calling a live broker will generally cost extra.

In conclusion, while we are very unhappy about this recent development at Scottrade, Scottrade remains the best choice for most investors. BrownCO is now a very close second and for some a better choice. 

While we intend to keep portfolio compatibility high with the big three (and the best of the deep discounters), our overriding goal is to find the best funds. We will not be replacing the funds in our model portfolio that are now TF, or those requiring a transaction fee, with NTF funds to get back to the 100% NTF portfolios-like those we had when Scottrade did not charge these fees. 

Keep in mind funds that are NTF usually have higher expense ratios, which is why they can afford to pay off the brokers for NTF status. Usually the extra $5 - $24.95 for a buy in a cheap fund often pays for itself in lower fund costs over time, although this is less so with very small buys. Investors can always buy a fund directly through the fund company for no extra fees whatsoever. Some that are loyal to Schwab or Fidelity could consider keeping half their portfolio at a cheaper discount broker (or even at Vanguard) to buy the lower fee, non-NTF funds in our model portfolios.

Thanks to all who emailed or posted comments about choosing a broker. We know this is an important issue, and we are always looking to find the best fund brokerage platform for our subscribers to follow in our model newsletter portfolios.