Investor Brain

Saturday, March 12, 2011

New Tools to Help Manage Risk

In preparation for our 16th annual review of online brokers, to be published March 14, we have spent the past few months investigating new services and tools from 24 firms. Four brokers we are studying are new to our review process.

So, what’s new this year? For one thing, brokers are offering more tools to help investors manage their risk. Several have also introduced money-management services, taking another step toward full-service brokerage capability. Notable among them is Charles Schwab (http://www.schwab.com), which acquired Windward Investment Management (now called Windhaven Investment Management), an advisory firm that managed nearly $4 billion in three broadly diversified portfolios invested primarily in ETF, or exchange-traded-fund securities. In March Schwab customers will be given access to these portfolios, at an additional fee that has yet to be disclosed.

Schwab (ticker: SCHW) is also offering five new Pimco-managed Municipal Bond Ladder separately managed accounts, expanding its fixed-income offerings. These are designed for people seeking tax-advantaged assets and income generation, particularly retirees.

E*Trade (http://www.etrade.com) also made a move into the managed-accounts arena, launching Managed Investment Portfolios, which offers one-on-one professional portfolio management of ETFs and mutual funds, with a minimum investment of $25,000. Another service, Unified Managed Accounts, is for clients with assets of $250,000 or more. This is a professionally managed wrap account that includes stocks, mutual funds and ETFs. E*Trade’s (ETFC) fees for this are based on the amount of money under management.

MANY BROKERAGES HAVE STEPPED up their efforts to court active stock and options traders. There has been a major push to offer additional tools for options traders, including education offerings to make newbies more comfortable.

Fidelity (http://www.fidelity.com) enhanced its options trading with additional research, including expanded volatility data. The site also includes the ability to model the profit or loss potential of an option strategy before placing a trade.

At tradeMonster (http://www.trademonster.com), more than 100 scanners were rolled out in a new LiveAction tool, which enables users to scan the universe of available options based on volatility, unusual activity, and fundamental and technical data.

Many brokers are launching new customizable trading platforms that open in a browser and can run on any computer. In the past, a user had to download a huge file and install a software platform to get this capability, and few of those programs ran on non-Windows systems. The new Web-based platforms are, for the most part, much better trading tools, and can be customized to fit your trading style.

A brand new brokerage firm, gxTrader (http://www.gxtrader.com), opened its virtual doors in late February. It won’t be included in the brokerage review because it is too new, but the trading platform might interest those who like a visual analysis tool.

GxTrader’s software, Visual Trader, comes from Nirvana Systems, and is version 8.0 of that analysis tool. It has trading capabilities built in. Getting started was somewhat difficult, as the program, which runs only on Windows, is a 70-megabyte download. It calls on several Microsoft Visual Basic libraries, which must also be downloaded. Once the program is installed, you’ll have to download another huge file to access the necessary historical data. In all, the process takes about an hour.

Visual Trader is designed to show movement and changes in momentum across a sea of trading opportunities. It displays a three-dimensional map that can be rotated and flipped. Industries are represented by circular disks, and individual stocks by cylinders. The color, width and height of each cylinder is generated by price changes and trading volume. A thick, tall, green cylinder would indicate a stock that is trending upward in price on heavy volume. A skinny red cylinder would represent a stock declining in price on thin volume. Clicking on a cylinder produces a graph of the stock’s price and volume changes over time. Click on the small “T” on the graph, and a trade ticket opens.

As of now only stocks, ETFs and options can be traded online at gxTrader; you must call a broker to trade mutual funds and bonds. Commissions are a half-cent per share, with no minimum, so a trade of 500 shares will set you back $2.50. Options commissions are 85 cents per contract. You’ll pay $99 monthly for the software, though that fee is waived if you trade more than 10,000 shares per month. 

Published in Barron’s, March 7, 2011. 

Friday, March 11, 2011

Scoring Rubric for the 2011 Online Broker Review

We put 24 online brokers through a variety of paces.  To participate, each broker filled out an extensive Excel-based survey, and gave us access to a live account.  Several brokers we contacted to take part in the survey, including Vanguard, could not give us a live account, so they are not included in the survey. 

Here is what we went through to rank the brokers this year. 

WE RANKED OUR 24 BROKERS USING THE FOLLOWING MEASURES:

Trade Experience: Working with a live account, we looked for a real-time quote and executed equity trades during market hours, making market buys and limit sales of a stock or exchange-traded fund. A real-time quote that is displayed without any additional user input (such as typing the symbol into a separate box or hitting a “Quote” button) receives credit here; if the trader has to make a duplicate entry of the ticker symbol to get a quote, the broker got zero.  We looked for a real-time streaming quote that updates automatically.  We checked out the ways a trader is told that an order is executed, such as pop-up notices or an order status screen that is updated when the order fills. 

Following the market buy, we tracked the execution and portfolio reports. We looked for pre-filled order tickets when selling a position, which eliminates possible errors during the closing process. After entering a limit-sale order, we examined the open-order reports and looked at ways to check the progress of the order, as well as ways to adjust the limit price or cancel the order. A key component going forward is the ability to select a tax lot when closing a position. 

We also placed options orders, using options’ order-entry screens when available. We also examined mutual-fund, bond, and (when available) futures, commodities and foreign-exchange order-entry screens. Methods for placing conditional orders, such as one-cancels-another or one-triggers-another, were checked out.
An overall score of 5 in Trade Experience means the order entry-and-execution process flowed easily from one step to the next, with streaming real-time information (including buying power and margin balance) available when needed.

Trading Technology: The availability of price-improvement strategies and smart-order routing technology (which finds the best bid or offer) are necessary to earn a 5 in this category. This year we asked whether a broker’s order routing engine used a spray or sequential engine; spray routing contacts multiple venues simultaneously and are less inclined to execute orders via routes that offer payment for order flow.  Brokers offering price improvement—a sale above the bid price, a buy below the offer—received a fraction of a point depending on the portion of their transactions that benefited.

Top marks were earned by brokers who offered a wide array of order types, including conditional orders, and had spray order routing technology. The ability to place a trade from a graph earned a fraction of a point. In addition, we looked for ways to customize the trading experience, such as setting a default number of shares or contracts, to speed order entry.

Usability: A 5 here means the site or program was easy to use and well-designed, didn’t bog down when moving from screen to screen, and can be tailored to the user’s needs. We looked at how easy it is to get started on the platform or website as a new customer. Constant availability of a trading ticket, and easy access to research and account status data is key. Being able to easily switch from one area of the website or program to another is key here, as are customization options. 

Range of Offerings: We awarded points for the diversity of investments that can be traded online, with partial points given for those that can only be traded offline. Since all the brokers allow long and short stock-trading, as well as single-leg options orders online, we don’t award points for those transactions. We asked brokers how many stocks, on average, their customers can sell short, and awarded up to a half-point based on their answer. Complex options trading, and the availability of mutual funds, bonds, futures, commodities and international trading were also considered. A 5 in this category means you can execute all of these transactions online.

Research Amenities: This category measures the quality and accessibility of research, quotes and charting. We looked for research, news and charting linked to a customer’s portfolio and watch lists; the quality of third-party research and its integration with the rest of the site; and the availability of screeners, with special emphasis on options-strategy screeners. Brokers also won points for offering real-time streaming quotes at no additional cost, powerful charting capabilities, and Level II quotes.  Partial credit was awarded for features that generated an extra fee. 

Portfolio Analysis and Reports: The emphasis here is on clearly laid-out reports, updated in real time, showing current balances, positions and margin status. Portfolio-analysis reports, with links to news and research, as well as extensive transaction history, are most desirable. Tax reporting also falls in this category. Full credit is given for reports that can be created on the broker’s website, with no additional fees or data entry required.  Partial credit is awarded to brokers that populate services such as GainsKeeper and Maxit (tax analysis and reporting programs) for an additional fee. 

Customer Service and Education: We sized up online help such as live-chat capability, user guides and frequently-asked-question files. Offline help was assessed by making calls to customer service, and weighing the brokers’ reports of the average time spent on hold when a customer calls in. We took a look at the education offerings, both online and live. The ability to visit a broker in person, and to access the account via a mobile device, is taken into account here.

Costs: We looked at commissions for stock and options trades and margin interest rates, giving more points for lower costs. We scaled the points awarded so that the lowest costs in the group earned the maximum number of points, with fractions (and occasional zeros) given to the more expensive brokers. Stock and options commissions are the biggest factor here, but mutual-fund and other transaction fees are also considered. A 5 could be earned here by very low stock and mutual-fund commissions, $4 or less for 10 options contracts, margin interest rates below 2%, and no account-maintenance fees. 

Saturday, February 26, 2011

Getting a Tax Break

A large number of online brokers still don’t give investors much choice on the accounting treatment of their stock sales.

When we recently surveyed our readers about what they most wanted from their online brokers, a majority said they were concerned about the new Internal Revenue Service cost-basis regulations that go into effect this year.

Brokers are now required to report the cost basis of any of your stock holdings to the IRS when you sell them. Those cost-basis reporting requirements will be extended to mutual funds in 2012 and to options in 2013.

On the face of it, having your broker report your cost basis should help at tax time. You won’t have to dig around and figure out how much you paid for a certain stock because it will be right there on your 1099. In theory, at least, the new requirement is straightforward. But it opens up quite a few cans of worms.

One feature we look for when we review online brokers–either individually or as part of our annual rankings (the next one is due out March 14)–is the ability to choose which lot of stock you’re selling at the time you place your closing order. For instance, if you’ve been piling up shares of General Electric (ticker: GE) over time, purchasing several hundred a year for the past 10 years, you will want to specify exactly which batches of those shares you’re selling.

THIS IS AN IMPORTANT ISSUE. You may want to choose the highest-cost lots of stock that you’ve held for more than a year to minimize your capital-gains tax. Or you may want to sell your cheapest lots and just take the tax hit now. If you’re the sort of investor who buys the same stock, especially if you plan to hold it for the long term, being able to choose which shares you’re selling will help you control your taxable income each year.

Most brokers have you set up your cost-basis system when you open an account, selecting LIFO (last in, first out), FIFO (first in, first out) or average cost as their system of tax reporting. But few brokers let you choose which shares you are actually selling when you close a position.

Among those that have built the capability into their platforms: E*Trade (http://www.etrade.com), Fidelity (http://www.fidelity.com), MB Trading (http://www.mbtrading.com), optionsXpress (http://www.optionsxpress.com), Muriel Siebert (http://www.siebertnet.com), Charles Schwab (http://www.schwab.com) and TD Ameritrade (http://www.tdameritrade.com).

OptionsHouse (http://www.optionshouse.com) is rolling out a new platform this month that lets a customer pick a tax lot.

Brokers that focus on active traders, such as Interactive Brokers (http://www.interactivebrokers.com) and Lightspeed Trading (http://www.lightspeed.com) don’t let you choose a tax lot, but they also don’t expect their customers to hold onto their positions for very long.

AS STEVE SANDERS, vice president at Interactive Brokers, explains, choosing a tax lot before a trade just isn’t very important to his customers, though it may be to other sorts of traders. Because IB clients typically buy and sell very quickly, “our customers wouldn’t have time to choose lots before a trade,” Sanders notes. Instead, the customers can let IB’s computer decide how to match a particular trade to specific tax lots.

In fact, few brokers who focus on buy-and-hold investors make it easy to link trades and tax lots.

For example, to assign a tax lot, a Scottrade (http://www.scottrade.com) customer must call the firm the day after a trade. And quite a few, including Firstrade, eOption, Cobra Trading and TradingBlock, either don’t allow you to choose or ask you to call a broker.

The bottom line: Make sure that your online broker offers you the tools you need.

Published in Barron’s, February 21, 2011.