The term brokerage house refers to a firm that charges a commission for facilitating a variety of financial and investment services. Through their stockbrokers, brokerage houses allow investors to buy and sell publicly traded securities such as stocks and bonds.
How Do Brokerage Houses Work?
Also referred to as a brokerage firm, a brokerage house functions as a middleman between the buyers and sellers. It provides services to its clientele who wish to trade stocks, bonds, and other securities, by facilitating trades at the best possible conditions. In exchange for providing these services, the firm charges a relatively small commission.
A broker is a person who buys and sells stocks on behalf of a client, may give advice, and always charges a fee. A brokerage firm brings together the two sides of a trade and facilitates the transaction.
While it’s not compulsory to use a broker, investors have to use either one of them. This is because securities exchanges only accept orders from exchange members, and not from retail investors.
Over 38 million trades occur on the New York Stock Exchange per day, and over 33 million on Nasdaq. It’s virtually impossible for all market participants to execute their trades without the help of brokerage firms facilitating the trades.
But transaction services are not all that brokerage houses do. They may also:
Employ a staff of analysts who provide recommendations to investors;
Offer loans to approved investors to purchase securities on margin;
Provide clients with holistic financial advisory services;
Have staff tax experts to help clients minimize their taxes, and so on.
Whether or not a brokerage house offers these services depend on the type of firm they are, which we cover in detail below.
Types of Brokerages
The kind of services investors can receive, whether the services are tailored to their needs, as well as how much they pay, largely depends on the type of brokerage firm they opt for. Thanks to discount brokerages, today it’s possible to trade securities without any charges – no commissions, no service fees, and, more often than not, no withdrawal or deposit fees.
The lines are blurring, though. More and more full-service brokerage firms are lowering their prices to get a competitive edge, and discount brokerage firms are introducing fee-based services. Regardless of the business model, almost every brokerage firm offers an online trading platform as an accessible front for all kinds of investors.
Full-Service Brokerage Firm
Also known as a traditional brokerage, a full-service brokerage firm offers its clientele a wider variety of services, such as estate planning, income tax advice, and security analyses. They typically charge an annual custody fee or a commission, or both.
While the likes of Merryl Lynch still mainly appeal to the more affluent individuals, many full-service brokerages have begun to offer discounted services as well.
Discount Brokerage Firm
A discount brokerage is usually an online broker, offering online-only, DIY investing services. Charles Schwab is generally considered the first discount company, but it was Robinhood that changed the industry by introducing no-commission trading. This led many competitors to lower or completely eliminate trading fees.
When they first appeared, their services were largely limited to buying and selling securities and derivatives trading. Many of their discount brokers servicing primarily retail investors have begun to add paid, higher-tier services into their offerings.
Robo Advisors
A robo-advisor is an online investing platform that relies on algorithms to implement trading strategies on behalf of clients. It sits somewhere in the middle of full-blown investment and DIY investing, and it’s getting increasingly popular as a swathe of beginner investors seek affordable expert help to implement passive investing strategies.
Much of the attraction comes from their affordability. Although it varies by the platform, many charge between 0.25% and 0.50%, incurring a much lower fee compared to the cost of traditional investment advisory services.
Brokers usually charge fees for every transaction, even the ones that operate on a no-commission basis.
Full-service brokerages may levy separate charges, such as custody fees, advisory fees, trading fees, and so on. They are, though, increasingly introducing a ‘wrap-fee’, i.e., an all-inclusive charge that covers all of the regular charges. It’s usually around 1% to 3% of the account balance.
As we mentioned before, we also see that many brokers move away from commission-based trading, and they make up for the loss in more subtle ways.
Payment for order flow (PFOF) is one of the most common methods to do so. When an investor places a trade, the trading platform then routes orders for execution to a particular exchange, and in return, they gain a small fee. While this helps tremendously in keeping the prices low, it results in poorer execution quality as the order is not routed to the optimum exchange.
While this isn’t a major problem for a big chunk of retail investors, it’s known to annoy day traders whose returns are affected by minute changes in execution quality.
Opening Accounts With Brokerage Firms
Opening an online brokerage account is the easiest way to start investing or trading with a brokerage company these days. It’s as easy as visiting a website or downloading an app on your phone or tablet. We walk you through the process below.
Choose a broker that fits your needs
There are several areas to consider when browsing brokers, most of it boils down to your investment style and experience.
Are you interested in staying abreast of markets at all times, or are you more of a buy-and-forget type of investor?
Active investors who wish to stay engaged in the markets usually hold stocks, exchange-traded funds (ETFs), and mutual funds. Derivatives trading, which largely comprises options and futures, is also very popular, especially among more experienced traders. There’s a range of online brokers that offer tools that can help with implementing derivate strategies.
By establishing the kind of assets you wish to trade with, you can understand the tools you require. Active engagement requires intense research and analysis, and therefore tools like advanced charting, asset screeners with plenty of filters, or real-time data stream.
For those who seek a hands-off approach or beginner investors, robo-advisors or full-service brokerages, where there’s sufficient input along the way, might be better suited. For beginner investors, it also makes sense to opt for a brokerage with far-reaching educational materials that will allow them to learn the ropes.
Apply for a brokerage account
The application process for brokers can seem hefty and nosey, but it’s for a good reason. It comprises personal questions in line with knowing your customer requirements, as well as questions enquiring about your financial circumstances and attitude towards investing and trading.
For the first part, be prepared to submit a photo of your government-issued photo ID, social security number, date of birth, and address.
The second part typically includes questions that assess your risk tolerance, income, tax bracket, and the nature of your employment. These questions mainly help brokers classify you, which in turn can direct the services they can offer.
Despite the process being long and oftentimes complex, the whole process lasts less than a day.
Fund your account and start investing
You have to fund your account to start trading. It’s also worth noting that it’s still customary among some brokers to require a certain amount to activate your account, although it’s possible to find many that don’t levy such restrictions.
There are plenty of options on how to fund your account, but more often than not, bank transfers are the cheapest and most straightforward way to do so. Card transfers may also have similar levels of accessibility and ease, but they usually come with additional processing charges.
Credit card transactions, in particular, may be a serious undertaking. If you’re planning on using your credit card, check with your card issuer or bank to see whether any payments to an online trading platform are considered cash advances. In this case, you will not have a grace period before interest starts to accrue on your debt.
Depending on your form of transfer, there may be some days between you opening your account and starting investing. Use that time to get familiar with the platform, test the navigation, and perhaps set a watchlist for the stocks you wish to buy once your account is up and running.
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