By Chana R. Schoenberger, Forbes.com
One of the most difficult things to do on this planet is to trade yourself rich. So we are not advocating that you try to do that. But perhaps by acting a bit more rationally you have most of your investable wealth segregated in low-cost buy-and-hold positions (like index funds), and yet you would like to trade very actively with the 10% or 20% remaining. What's the cheapest way to do that? Now we can comfortably give you some advice.
Consider two approaches for those who handle their own investments. The first is to pay á la carte. Online discount brokers like Charles Schwab & Co., Scottrade and TD Waterhouse will oblige. Schwab's basic commission is US$13 for up to 1,000 shares, but the price drops to US$10 if you do at least 120 trades a year or have at least US$1 million of assets (household total) at Schwab. This arrangement entitles you to free research reports.
The second deal is to pay an asset-based annual fee (typically 1%) that allows you to trade for free, up to some limit. These accounts are most commonly found at full-service brokerages, but with this arrangement you get no research. Don't expect any financial advice from brokerage staffers, who, unlike money managers, have no fiduciary responsibility to you. You'll get zero help on an asset-allocation plan, estate planning or tax strategy, not to mention old-fashioned stock picking. (A third option: Most investors like to have a pro run their money and pay him a flat fee to do this for them.)
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Most big brokerages offer the second kind of account. Merrill Lynch leads the market with a 36% share, followed by Morgan Stanley, UBS and Schwab. These accounts attract better-off investors, with the average account size at US$280,000. "They're the classic active traders," says Jeffrey Strange, senior analyst at consulting firm Cerulli Associates in Boston.
It makes little sense for folks who like to buy and hold stocks and mutual funds to pay a yearly fee. The 1% bite is too big for a fairly passive account. Neither is it a good deal if you are day trader because these accounts have upper limits on how many times you can trade. Day traders can do thousands of transactions in a year.P>
"Ask the questions, so you know what you're going to get and what to expect," says Diana DeCharles, a financial planner with AIG Financial Advisors in Shreveport, La.
A typical fee-based do-it-yourself offering is the one from Morgan Keegan, an arm of Regions Financial, called the MOR Partners account. Clients can trade up to 150 times a quarter, hence 600 per year before the firm starts looking at them closely, and they get quarterly reports on their accounts. Let's say you have that average US$280,000 in Keegan's MOR program. You'd be paying US$2,800 annually in fees. The Schwab customer has to do 280 trades a year to owe his broker that much.
Should the accounts be smaller, however, Keegan looks better. Say you have US$100,000 in this trading account. Keegan would hit you up for US$1,000 a year. At Schwab you'd pay more if you exceeded 77 trades.
Alas, not every broker abroad in the land is scrupulous about who should be in what kind of account. "Brokers see these accounts and dollar signs light up in their eyes," says Susan Merrill, the New York Stock Exchange's enforcement chief. Brokerage Raymond James got slapped with a US$900,000 fine from the National Association of Securities Dealers in 2005 for herding low-volume traders into annual-fee accounts. In August the NYSE fined brokerage firm A.G. Edwards US$900,000 over similar accusations. The stock exchange found investors who paid ten times as much in fees as they would have if they'd been paying commissions. A.G. Edwards says it changed its policies in late 2003 and that it now reviews activity records on a quarterly basis to make sure clients are in the right type of account.
Now let's get back to that threshold question: Can you make money trading feverishly? Some people have done so. The group includes some famed hedge fund managers like Michael Steinhardt and Steven A. Cohen, and it includes amateur day traders practicing their art in the late 1990s. However, a hedge fund with a billion dollars probably has access to information or support staff that you don't with your US$100,000. As for the ephemeral day traders, their success owed more to a bull market than to their trading skills.
If you must gamble, do it rationally. Park your first US$1 million at Schwab in a well-diversified mix that you can hold for years. Take your next US$100,000 to Keegan, and have some fun. In selecting which positions to close out on the trading account, lean toward the ones with losses. Realized losses can absorb any amount of realized capital gains (from other stocks, or from a Klimt), plus up to US$3,000 a year of ordinary income. Unused capital losses can be carried forward indefinitely. A US$20,000 loss carryforward pulled out of your hyperactive account would come in handy if a company in your buy-and-hold account got taken over, creating an involuntary US$20,000 gain.
"Brokers see these accounts and dollar signs light up in their eyes."
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