So you're thinking of investing online, executing self-directed day trades, securing that retirement nest egg? It's possibe - regardless of the prevailing market winds - but there are a few things you should know.
For starters, there's the fact that on average, investors receive better returns when they hire a full-service broker rather than going it alone, says Bruce Dickson, senior vice-president of Scotiabank Group's discount brokerage.
Dickson's assertion that "you get what you pay for" tends to be borne out in the research conducted on the subject - and seems logical to boot.
On the other hand, according to E*Trade Canada president Colleen Moorehead, "the economic argument behind discount computer trading is compelling." She compares equity trades starting at $27 for up to 1,000 shares with an E*Trade account, zero fee mutual fund trades and margin loans at prime, with the hundreds of dollars per trade charged by the top full-service houses.
Indeed, while full-service brokers say they're not about to abandon their focus on high net-worth clients, they do agree that market forces have forced both the discount houses and full-service brokerages such as Merrill Lynch & Co. to reach something of a compromise.
Self-help
More and more, the full-service firms are offering self-directed options within the context of an investment advisor/client relationship and giving clients the ability to complete transactions online. Meanwhile, E*Trade in the United States - a unit of E*Trade Group Inc. of Palo Alto, Calif. - is adding financial content, investment tools and online research.
The Canadian version of E*Trade, owned by Versus Technologies Inc., has conducted online surveys since it opened its site for free trial memberships in Canada one year ago. Data shows trial members are primarily concerned with investment research, security, trading fees/commissions and speed of order execution. "We're pleased that the survey reveals that investment tools are of the highest importance," says Moorehead.
The E*trade site provides tools including mutual fund research, online screening and up-to-the-minute quotes, interactive charts and a portfolio manager "second to none," Moorehead says. The Internet enables ready access to raw data, she adds, whereas a few years ago only a licensed broker could access "real-time" stock quotes. As well, the online sites have augmented this information with Java technology that helps track portfolio components and flags news stories related to holdings.
Sites such as E*Trade allow trades in Canadian and U.S. stocks, Canadian mutual funds and Canadian/U.S. index options, with option trades priced higher than straight equity trades. There are no monthly fees, although extra services such as account transfers incur a charge.
An E*trade registered representative can also trade GICs, Treasury Bills and other fixed income investment instruments. Investors will need a Web browser, usually Netscape Navigator 3.0 and up or Microsoft Explorer 3.0-plus.
Despite these services, E*Trade Group Inc.'s has not yet managed to transform itself into an online Charles Schwab Corp., the most diversified and profitable of all the discount brokerages, and its stock has fallen to US$18 in early September from US$70 only a year before.
As a result, the company's American arm has sought to add new revenue by attracting richer clients and offering online banking and financial planning advice – steps not yet taken in Canada.
Full-serve
For their part, almost all of today's investment firms offer online trading, as well as self-directed investment products, though they're often used as a loss leader to obtain new full-service clients.
In this sense, according to Scotiabank's Dickson, full-service brokers are adapting to the emergence of the online and discount competition, "but are not overwhelmingly bracing the concept."
But the discount houses, says Merrill Lynch Canada spokesman Peter Kahnert, have forced a new emphasis on containing increases in trading fees and commissions across the industry, as well as on providing online sources for investment research.
Among the most well-known of these sources are Investing Online Resource Center investingonline.org, which offers a quiz to help you decide whether to invest online, and The Motley fool, which offers investment advice in simple language.
Discount brokerages at the major banks can be accessed through the banking Websites. But the full-service brokerages point to one essential problem with these myriad electronic sources - they're available to everyone at the same time.
Still, with 15% of all stock trades on the technology-weighted Nasdaq conducted by so-called day traders using personal computers, online investing cannot be ignored
Here, then, are some of the pros and cons of doing it yourself:
- Self-directed fees are lower, though if you're investing in mutual funds, you must still pay fees to fund managers in the 2.5% to 4% range, particularly for speciality funds. Commissions can add up for active traders and can yield tax-inefficient capital gains.
- You have a feeling of control.
On the other hand:
- Professionals such as lawyers often lack the necessary time to manage a portfolio.
- There's a belief that self-directed investors are more vulnerable to basic investing pitfalls than those subject to the imposed discipline of a financial advisor. That is, they're quick to jump on hot stocks, allocating too many assets to too few baskets and rendering themselves especially vulnerable to falling markets.
- There's a tradeoff between service and price. Truly do-it-yourself online trades can be executed for as little as $8, while discount transactions involving substantial levels of services can cost more than $80.
What you need to know
Online investors, therefore, should keep the following in mind:
- An E*Trade account can be opened for a minimum of $1,000, but other discount brokerages can require an initial deposit of up to $20,000. Be sure to ask what happens if your account falls below the minimum deposit required.
- If you plan to borrow from a broker to invest, be clear about the terms under which a margin call can be issued, and how much time the client is given to settle the account. Demand interest at prime.
- Make sure that the online investment house offers access to the exchanges you want before signing up. Not all brokers offer trades on, for example, on the Canadian Venture Exchange.
According Susan Viger, vice-president of private financial services at T.E. Financial Consultants Ltd. in Toronto, all new investors ought to set out a chart that deals with some basic questions:
- When do you want to retire?
- Will you stay in Canada and keep your home?
- How much money will you need to live on after tax?
- Do you have other income such as pensions to supplement your retirement income?
- Do you wish to leave an estate to your children?
- How much money will you need from your portfolio to meet your goals?
- What fees are you prepared to pay?
Once these fundamental questions are dealt with, you must decide if you have the time, expertise and inclination to invest yourself, and whether you have the resources to recover from inevitable mistakes.
If so, Viger says the next step is to decide on asset allocation, which accounts for more than 90% of an investor's return, after asset class and market timing. (Asset class refers to diversification in terms of industry, growth and price; it refers to all types of securities, including stocks, bonds and cash.)
Both asset class and allocation should be structured to manage risk. That is, it's generally considered wise to combine value and growth investments, equities and fixed instruments, and to mix types of securities issuers to minimize capital risk.
Keep in mind, too, that there are alternatives to and options within pure self-directed investing:
- Hire a full-service broker as a sounding board, rather than a financial planner, leaving the final decisions to yourself.
- Manage a portion of your investments, while leaving professional managers to handle the rest.
- Combine fee-only planning with investment counselling. This type of services involves an investment counselor who manages your portfolio for a fee, but it doesn't require fees to mutual fund companies or to the counselor.
- Hire an adviser, with the fee generally based on the size of your account as a percentage of the market value of your portfolio. In other words, if the market goes up, the fees rise with it. Fees are based on a sliding scale: the more money you have, the lower the charge. Clients usually need at least $100,000 to set up an account.
- Buy index funds, which mirror stock indices and carry low fees.
- And finally, avoid back-end loaded mutual funds, which are expensive, usually non-negotiable, and may lock you into the fund for seven years or more. Front-end loads can be negotiated, but fund manager fees remain fixed, regardless of the value of your holdings.
Michael Lewis is a Toronto business and legal affairs writer.