Investor Brain

Friday, March 12, 2010

Scoring Rubric for the 2010 Barron's Online Broker Review

An abbreviated version of this will appear in Barron’s.  I wanted to spell out exactly what went into the point scoring.

WE RANKED OUR 22 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 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. 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.

An overall score of 5 in Trade Experience means the order entry-and-execution process flowed easily from one step to the next, with 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) were necessary to earn a 5 in this category. 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. 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. 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.  This year, an additional consideration was the availability of a trading journal, allowing the user to capture market conditions at the point of the trade and take notes on the thinking behind entering that order.  A Barron’s reader requested this feature. 

Help and Customer Access: 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. This year, we increased the points awarded for mobile access in this category.

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 commissions are the biggest factor here, but options and mutual-fund transaction fees are also considered. A 5 could be earned here by very low stock and mutual-fund commissions, $5 or less for 10 options contracts, margin interest rates below 2.5%, and no account-maintenance fees. 

Saturday, February 20, 2010

One Client, One Quote

WHEN CHARLES SCHWAB IN LATE JANUARY WENT to a single, lower fee for online stock trading, we figured other changes were on the way. We were right. Fidelity ended its tiered pricing structure a few days later, and E*Trade followed suit just a few days after that.

As we discussed on Barrons.com Jan. 28 ("Has A New Price War Broken Out in Online Trading?” ), Schwab’s (http://www.schwab.com) peers and competitors interpreted the pricing change as a positive, putting the fees more in line with the rest of the world (at $8.95, the commission is in the middle of the industry pack), rather than setting off a quick race to the bottom. The big shift is that different prices for different customers appear to be coming to an end, and for that, hallelujah.

James Burton, president of Fidelity’s (http://www.fidelity.com) retail brokerage, admits his firm’s price change, which drops all stock trades to $7.95 per transaction, was a response to Schwab (ticker: SCHW): “It’s a competitive business. We listen to our customers’ feedback and do what it takes to stay highly competitive.”

One twist from Fidelity is that customers can trade 25 iShares exchange-traded funds free. This suite of 25 BlackRock ETFs, according to Burton, covers the key U.S. asset classes: large-, mid- and small-cap, with a mix of growth, value and blend funds. There are also international and bond ETFs available. “Investors who want to use passive index products to supplement or form the core of a portfolio can now do that at no cost,” says Burton.

BlackRock’s iShares S&P 500 ETF (IVV) already has an extremely low expense ratio of nine basis points (0.09%), according to Burton. If you held $1,000 worth of IVV, that would cost you 90 cents a year in administrative and other fees, compared with the 0.5% to 3% most mutual funds charge. And then you don’t have to worry about other transaction costs, bringing the relative cost of owning or trading ETFs way down. “We’ve removed that incremental cost,” says Burton.

E*Trade (http://www.etrade.com) didn’t toss the tiered structure entirely, but eliminated the top tier of $12.99 per trade for less-active customers. Now the top commission is $9.99 per trade; active traders with more than 150 trades per quarter will pay $7.99. In addition, the firm will stop charging a quarterly account-service fee of $40 in the second quarter of 2010. E*Trade (ETFC) is also dropping a per-share charge for trades of more than 2,000 shares.

Years ago TD Ameritrade made a big splash when it announced that all stock trades would carry a $9.99 commission. It was a big deal because the broker wasn’t playing the tiered-pricing game. With E*Trade hanging on to its tiered pricing structure—albeit a reduced one—the industry can’t quite say a final good-bye to this idea. Which is too bad.

LIGHTSPEED LAUNCHES WEB TRADER Lightspeed (http://www.lightspeed.com), which has focused on active retail traders as well as proprietary trading groups, hedge funds and algorithmic “black box” firms, noted with interest that about 30% of its new clients in 2009 came from traditional online brokers. Some of these new customers, the online broker says, previously were intimidated by Lightspeed’s extremely customizable software-based trading application. Now the firm hopes to make it even easier for them to join up.

Stephen Ehrlich, Lightspeed’s CEO, says most of the new customers “graduate” to Lightspeed’s platform, but many have asked for a Web-based application. “They’re just about ready to make that jump, but to get ready they want to use the Web-based platform, use the demo of the software platform and then make the move,” he notes. “Our Web Trader will remove that intimidation and help the customer coming from a traditional broker make the switch,” says Ehrlich.

The Web Trader went live on Feb. 2. Customers can trade stocks and options on the Web Trader but must use the Lightspeed software application to trade futures. Lightspeed charges 0.395 cents per share for stock trades, and 50 cents per contract for options transactions, with no minimum.

One drawback I see is that customers must choose one platform or the other, and can use only one at a time. So once you begin using the software platform, you can’t go back and use the Web application. Ehrlich notes the Web platform is version 1.0 and Lightspeed will continue to work on it, making it more powerful. I hope it will be interchangeable with the software platform in time as well.

SCOTTRADE’S FOREIGN FORAY

Customers of Scottrade (http://www.scottrade.com) can now place orders online for approximately 3,700 international securities, including many Canadian stocks. The securities include American depositary receipts along with U.S.-traded foreign stocks from approximately 20 countries on six continents.

In addition, Scottrade added an International Investing filter to its stock screener, which can be found in the Quotes & Research section of the site. The online Knowledge Center now includes research materials about ADRs. The section includes information about different types of foreign securities at Scottrade, how to trade them and how to read the symbols.

Commissions are $7 per transaction for stocks priced over $1 a share. All transactions are completed in U.S. dollars, including dividend distributions.

IS THAT STOCK FAIRLY PRICED?

Market Topographer (http://www.markettopographer.com), launched in mid-January, attempts to provide the answer. The site combines fundamental and behavioral analysis, focusing on a company’s relative risk profile, its trading multiple, and whether expectations embedded in its share price are achievable.

Free during an evaluation period, the platform is driven by a financial model with 20 years of data, analyzing 12 core risk-assessment characteristics. The suite of tools is designed to be agnostic and avoids buy and sell signals. You’ll find comparisons between two stocks, with the price broken down into a variety of components, such as expected earnings growth and dividends paid.

Check out the free trial, because it appears to me that this will be an expensive site once the publisher starts charging.

Published in Barron’s 2/15/2010

Saturday, January 16, 2010

New Investor Tax Rules on the Way

Adapting to new rules for cost-basis tax reporting.

THE INTERNAL REVENUE SERVICE IN mid-December issued proposed regulations on cost-basis tax reporting. Under the measure, brokers would be required to report to the government the cost of equities sold by their customers in 2011. For 2012, they’ll have to report similar information about mutual-fund sales and, in 2013, options and fixed-income cost bases. At present, the cost basis of transactions is communicated only to clients, who are responsible for reporting it to the IRS. The comment period on the proposal ends on Feb. 8.

Investors who use online brokers have long complained to us that they have trouble getting accurate cost-basis information from the firms. So will the industry be ready in time to comply with the measure?

Even though the deadline for options is a little further off, figuring transaction costs there will be a particular challenge.

The new IRS rules will change the dynamics between investor and financial institution, says Cameron Routh, senior vice president of strategic products at Scivantage (http://www.scivantage.com). His company’s Maxit enterprise application provides real-time cost-basis and tax-based investment decision support to help financial advisors and individual investors minimize tax liabilities and increase after-tax performance. Several online brokers we cover have installed Maxit in their back offices, including TradeKing, Options- House and Just2Trade.com.

“Not only is the firm going to be reporting your cost basis to you, but they’ll also be reporting it to the IRS,” says Routh. “Some [investors] might blame the broker for reporting private info; firms are going to have to educate their customers.”

Every firm eventually will introduce its own solution. Scivantage, obviously, is encouraging its online brokerage customers to get an early jump by installing the technology that would let them meet the IRS requirements now. Routh believes that getting on top of cost-basis reporting will help retail investors, and improve the investment experience by offering pre-trade tax analysis, portfolio analysis, tax tools and other applications, to leverage cost-basis tracking.

Scivantage’s Maxit competes with Gainskeeper (http://www.gainskeeper.com), which is offered to investors through online brokers including Firstrade, Zecco and optionsXpress. Gainskeeper is also available directly to investors, who can import their transactions and run the necessary reports. Maxit doesn’t have a retail version for traders, but we wouldn’t be surprised to see one in the next year.

Frequent traders already have to report wash sales themselves. These transactions are triggered when one sells a holding at a loss, and purchases it (or something that is substantially the same, like a similar ETF) again within 30 days. The loss on the sale is disallowed, though you can add it to the cost basis of the new purchase. The changes in the IRS rules place a new burden on online brokers to track and report wash sales, including a detailed list showing each sale on a single line. Some active traders generate thousands of wash sales per year.

The complications of wash sales can lead to accounting nightmares if you have to make all the calculations on your own. Some online brokers report wash sales if you make the transactions on their Website, but the wash-sale rules apply even if, for example, you sell a stock at E*Trade and then buy one that is considered substantially the same at Charles Schwab.

Traders who opt to change their accounting method from cash basis to mark-to-market aren’t subject to wash-sale rules. But they open themselves up to a great deal of additional scrutiny. Mark-to-market traders are few in number and require heavy-duty tax software that can’t be found in the usual mass-market products. We recommend Armencomp’s TradeLog MTM (http://www.armencomp.com/gtttradelog/) for these hyperactive traders.

WE’VE GOTTEN A STEADY STREAM of reader e-mails responding to our recent plea for input about online brokers for our coming annual review. We’re still open to any thoughts you can offer.

If you’ve been using an online brokerage account over the past year, please drop us a line at electronicinvestor@yahoo.com . Thanks.

Published in Barron’s, January 11, 2010.