To buy and sell stocks, bonds and mutual funds, you need a broker. A broker can either be an individual licensed agent or a brokerage firm like Merrill Lynch, Smith Barney or Charles Schwab. The most basic function of a broker is to execute trades for the investor, but many brokers offer additional services like investment advice and portfolio management. Brokers make money by charging commissions on each trade and collecting fees from investors.
It's important to understand how these commissions and fees work. First of all, most brokers require a minimum deposit in your brokerage account. It's similar to a bank account, and the broker will withdraw money from it every time he or she needs to make a trade. The average minimum deposit is between $500 and $2,500, but it's not uncommon for minimums to be as high as $10,000 [source: Investopedia]. If you can't supply the minimum deposit, you can't work with the broker, so look for that information first.
As we mentioned, brokers make money by charging a commission on each trade. The amount a broker charges varies greatly between discount and full-service brokers. Traditionally, discount brokers don't do anything but execute the trade. Many online brokers, therefore, are discount brokers. You fill out the details of the trade on the Web site, hit "buy" or "sell" and someone on the other end makes the transaction. Discount brokers can charge as little as $5 to $15 per trade.
Full-service brokers do much more than just execute trades. They're professional money managers and financial planners who work with a client to develop a clear investment strategy and maintain a portfolio that supports that strategy. Because full-service brokers do considerable market research and meet in person with each client, the average full-service commission is between $100 and $200 a trade.
In addition to commissions, brokers also charge annual maintenance and operating fees. Some brokers even charge inactivity fees if you go for months without making a trade. And others charge minimum balance fees if your brokerage account dips below a certain level or amount. Before working with a broker, make sure you understand what fees apply to your account and how they will be calculated.
As a beginning investor, it can be difficult to choose between a discount and full-service broker. Discount brokers are cheap, but you get what you pay for: A discount broker doesn't get paid to give you advice. On the other hand, not all full-service brokers are worth their hefty commissions. Some are arguably salesmen who only peddle their brokerage firm's investment products. As we discussed earlier, they get paid by the trade. Some full-service brokers have been accused of encouraging clients to make multiple, unnecessary trades, which is an unethical practice called churning [source: Investopedia].
The good news is that there's a new generation of online brokers that fall somewhere in the middle of the discount and full-service extremes. You'll pay between $15 and $30 per trade, but you'll get more guidance and support than from a traditional discount broker. And now some full-service brokers are offering discounted, online-only trades.
Once you have a broker, it's time to develop an investment strategy. Read more in the next section.