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Which is the right online broker for you?

If you invest in listed securities, it is critical that you have a good broker working for you. Some readers have written in to ask which brokers to use so today I will share some of the considerations we take into account in choosing a broker and our experience with some of the brokers that we have used. As a self-directed investor, I only expect my broker to handle my transactions for me and not to provide me with investment advice. Hence an online broker is an obvious choice for self-directed investors like me as the brokerage fees are normally much lower when compared with a full-service broker. When comparing online brokers, most people tend to focus on brokerage fees and functionality of the broker’s trading platform. While these two items are important, many people neglect the most important consideration, which is, how safe is the broker?

On 23 June 2010, over 3000 of Sonray Capital’s clients found out the hard way when their brokerage accounts were frozen because Sonray had gone into voluntary administration. Sonray’s clients are considered as unsecured creditors and their money could be used to pay other creditors. Sonray’s collapse is the latest in a string of financial service firms to go under. During the global financial crisis, Opes Prime, Chimaera Capital’s Primebroker and Lift Capital all failed, hitting client accounts worth more than $1 billion. Although brokers are regulated by ASIC, brokerage clients do not get very much protection in Australia.

We have chosen to use CommSec as our broker for Australian listed securities mainly because of the safety aspect even though their trading platform is pretty basic and their brokerage fees are not that cheap. I like holding our stocks under our own separate Holder ID Number (HIN) and holding any cash meant for investing in a bank account in our own name, rather than in a pooled account with the broker. A few years ago, I contemplated switching to Spectrum Live, a broker who was highly recommended by one of the local options gurus because it had a much more sophisticated trading platform that allows you to trade 21 markets around the world, including stocks, options, CFDs, futures and foreign currencies from one account! As we invest in both stocks and options in the US and Australian markets, the ideal broker for us would be one who can allow us to trade seamlessly in both markets so I was keen to try this broker out. After completing the initial account opening paperwork, I noticed I had to fund my account by sending a cheque to Tricom Equities. I remembered reading something negative about Tricom Equities so I quickly googled them and found out that Tricom Equities has been fined a record $1.35 million by the Australian Securities Exchange for 10 breaches of the rules spanning three years including “blatant market manipulation”. That was enough to put me off using a broker like Spectrum Live, even if they have the best trading platform in the world. It turned out that they also use the Saxo Bank platform, which is the same platform as the one used by Sonray Capital.

Last year I opened an account with Interactive Brokers (IB) which is a US broker who actively operates in Australia. They also touted a sophisticated platform that allows you to trade different types of securities in multiple markets. As a US broker, IB easily passed the safety requirement as all US brokerage clients are protected by the Securities Investor Protection Corporation (SIPS), which will ensure clients get their money back if their broker goes bankrupt. Their trading commissions were also very attractive when compared with Australian online brokers but they do charge all kinds of other fees for services that are normally provided free of charge by other brokers. For example, you have to pay extra for live market data and it costs around AUD 30 per month to get real time prices for ASX listed securities. Their trading platforms are robust but not that user friendly and it was a lot more complex to complete an international transaction that I expected. I set my base currency to AUD and funded my account in Aussie dollars. I then decided to buy UUP, an Exchange Traded Fund which is listed in the US. The transaction seemed pretty straight forward. With a few keystrokes, I managed to buy UUP shares and I assumed they would simply take money out of my account to pay for the shares. When I looked at my statement at the end of the month, I was shocked to find out that I had been hit with interest charges, even though I had more than enough money in my account to cover the purchase of the UUP shares. I later found out that if I want to buy US shares, I have to do a Forex transaction first to buy the required amount of US dollars. If I do not do that, IB would loan me the US dollars to complete the transaction but would charge me interest for it. I found their statements and their margin calculations confusing compared with other brokers, and I had to pay a lot of hidden fees which I did not expect. After a few months, I finally gave up on the idea of using one broker for all our investments and decided to close my account with them.

For now we use two brokers – Commsec for our Australian investments and Thinkorswim (TOS) for our US investments. Although you can buy international shares like US listed shares and ETFs through Commsec, the commissions charged are very high compared to buying them through a US broker. It may okay to use Commsec if you plan to buy and hold a few international shares but it would be very costly if you plan to trade actively. As a US broker, all TOS client accounts are protected by SIPS. TOS has a high functionality trading platform with more features and functions than you will probably ever need and they provide some really great tools for the options trader. One of  my favourite tool is the Risk Profile tool which shows you the profit and loss and the probabilities of any trade you currently have on or are planning to put on. A sample screen is shown below (left click on the picture to enlarge image). You can change various parameters and forward the calendar to see what your position will look like in the future.

After you have used their trading platform, you will find other broker’s platforms clumsy and limited in comparison. TOS has been voted the best broker for options and best overall online broker in four out of the past five years by Barrons. As we mainly invest in stocks and options, TOS meets most of our needs well but it still has some drawbacks. One drawback of TOS is that you can only trade US listed securities and you have to fund your account in US dollars which currently does not earn any interest. Ideally, I would prefer to keep any uninvested cash in my account in Australian dollars but this is not an option with TOS. Another drawback of TOS is that its platform is not so robust. Their trading platform stopped working for about an hour during the Flash Crash in May 2010, which can be a big problem if you urgently need to close a position to limit losses.

Some other brokers that we have tried include E*trade and Optionsxpress. Compared to CommSec, E*trade has a slightly superior option trading platform but their brokerage fees are more expensive. (Update on 24 Oct 2010 – a couple of readers have told me they like E*trade’s website and back office. For option sellers, an important advantage is E*trade’s margin requirements, which are much lower than CommSec’s. CommSec requires twice the ASX specified margin whereas E*trade only requires the ASX  margin).

For trading options in the US market, TOS definitely has a superior trading platform compared to Optionsxpress. For now, CommSec and TOS are the brokers that best meet our needs. For anyone looking for a good US broker, check out this Barrons report. I have no hesitation in recommending TOS as their trading platform is a joy to use and their commissions are very cheap when compared to what Australian brokers charge.

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