Better, Not Just Bigger
That's what we found in our annual ranking of online brokers
By Theresa W. Carey
Barron's
Please fasten your seat belts and keep your hands and feet inside the car. The online broker roller coaster, which had seemed to slow down for a time last year, is taking off again. And as Barron's fifth annual survey shows, online brokers have to keep hurtling forward just to keep up with this fast-moving crowd. Stand still and you fall behind.
Surpassing the most optimistic projections, nearly one in two retail trades was placed online by the end of 1999, according to estimates by US Bancorp Piper Jaffray. But from the standpoint of the online investor, an even more important development emerges this year: We found the largest jump in quality since we started this series in 1996. That's not to say online trading is perfect, or even uniformly good; far from it. But as our survey found, the better online brokers have to work hard for your money -- and not with goofy advertisements or out-and-out bribes.
Sidebar: Now, Ben Graham Fans Can Also Trade Online
Sidebar: Belt and Suspenders
The improvements that stand out demonstrate the maxim that less is more, especially when it comes to the Internet. In the beginning, in 'Net terms, online brokerage sites were full of gee-whiz bells and whistles intended to attract computer-savvy early-birds. But now that folks who are investors and not PC jockeys are joining the stampede online, brokers are designing sites that attempt to give upscale customers the feel of a plush virtual office.
Not only have full-service stalwarts such as Merrill Lynch and Morgan Stanley Dean Witter gone online, but discount brokerage leader Charles Schwab recently bought U.S. Trust, an old-line provider of private banking and investment services to the carriage trade. Not to be left behind, J.P. Morgan and Goldman Sachs also recently announced plans for online services. Goldman plans to focus on investors with a mere $1-$5 million in assets when they go online. In contrast, investors who want to deal with carbon-based life forms at the firm generally will need a $10 million net worth. And you know it's got to be a hot concept when James Clark, the serial entrepreneur behind Silicon Graphics and Netscape, gets into the fray. He's backing something called myCFO Inc., which will pull together online financial services for the wealthy, from online brokerage to trusts, estates, tax planning and insurance.
Table: Ranking the Online Brokers
Table: How The Online Brokers Stack Up
Obviously, a lot has changed since 1996, when Barron's began ranking online brokers. Back then, only 8% of retail trades were placed online, and we found only 12 Internet brokers to examine. Now, according to US Bancorp Piper Jaffray, 48% of trades are done online and over 100 firms are in the business (the total changes almost daily, given new entrants and consolidations). Piper Jaffray figures that almost 13 million online brokerage accounts exist, and that a record 1.8 million were opened in last year's fourth quarter.
Online trading, thanks to extensive advertising, media attention, low brokerage fees and improvements in the Internet-based offerings, has hit the mainstream with a vengeance. And with the unprecedented bull market and the mania for all things tech and Internet-related, online trading has become a part of popular culture.
Granted, much of the trading volume is generated by a small percentage of very frequent traders. But as Bruce Zucker of mydiscountbroker.com notes, "We are beginning to see the second wave of online customers -- those who are less experienced at investing and who seek more online information about investment decisions." Those customers want easily accessible information and education, as well as the ability to make transactions with just a few keystrokes on their computers.
After 1998, when 30% of trades were executed online, it seemed safe to predict a slowdown in the growth of such trading. Well, reality proved us quite wrong. The number of daily transactions nearly tripled over the past year, to just under 900,000 per day -- surging 55% in the fourth quarter of 1999 from the third quarter's level. What could interrupt the constant climb in online trading? "Well, a bear market would slow it down," observes Jason Lind of Piper Jaffray.
Notwithstanding the popular impression, all the growth in electronic investing hasn't come from firms that are newcomers to the brokerage industry. Watching their customers transfer assets to online brokers, Merrill Lynch and Morgan Stanley reckoned that if they couldn't beat the Internet-based brokers, they'd better join their ranks. Piper Jaffray's Stephen Franco figures that $900 billion in assets are now held in online brokerage accounts, which he says is "a key statistic as many online brokers try to diversify their revenue mix and move away from their heavy dependence on trading volumes."
Martin D. Weiss, chairman of Weiss Ratings, which tracks brokers and calculates a safety rating based on the broker's financial strength, notes, "major firms that had resisted deep-discount commissions for many years are now jumping on the online bandwagon."
Online investors, for their part, are mostly happy with their experience, according to a survey commissioned by Fidelity Investments. The main regret of 10% of the respondents: that they hadn't gotten into the game sooner, or made more trades. The study showed that investors nearly double their trading pace, from 2.7 buys or sells a month to 5.5, in the first three months of going online, but then they slow to an average of 4.5 trades per month after that initial euphoria subsides. And if the current numbers aren't enough for online brokers, Forrester Research expects the number of accounts to quadruple by 2003.
Online brokers are also breaking into the international arena this year, with an increasing number offering access to markets in Europe, Asia and South America. Barron's reader Douglas Makepeace is especially interested in brokers that give access to markets outside the U.S., observing that "online brokerages have a big advantage here because the Internet never sleeps."
Another measure of online trading's growing impact is the recent "hacker attacks" that have plagued numerous electronic commerce sites. Schwab, E*Trade and National Discount Brokers have experienced occasional site slowdowns because of "denial-of-service" attacks on their sites. Any time a brokerage site crashes during the trading day, it makes the news. Nobody seems to care much when an online bank or credit-card company crashes, but let an online broker's site burp and CNBC is in the front row, breathlessly reporting the effects. It's equivalent to the coverage that aviation accidents receive, even though highway disasters take a far higher annual toll.
But if there still are a few bumps on the tracks, Barron's readers let us know. One of them, Richard Haass, a programmer who manages accounts with six different online brokers, is simply disgusted with the state of brokerage applications. He is especially disappointed with portfolio-performance reports, which was also the weakest area overall that we observed in our review of these 27 online brokers.
More to the point, one anonymous correspondent sent us an obscenity-laced missive detailing his frustrating experiences with several online brokers, in which he took the financial media to task for supporting sites that don't work to his standards. "The Internet is kind of like a dancing bear, the fact that it dances at all is amazing, so it has not had to dance well. The first evolution is done -- electronic brokers should now be opened up and the performance discussed."
And, of course, there are the lawsuits and the government agencies working to protect investors from themselves. One of the delights of trading online, for the educated self-directed investor, is the ability to place orders without having to talk to a broker -- who might talk you out of what you want to do, or talk you into something that might benefit the broker's bottom line more than your own. But for some people, the ability to trade cheaply, easily and often online acts like a drug, and these are the people the SEC and a variety of lawyers want to save from themselves. The Securities Industry Association -- an industry trade organization -- formed an online trading group last year, which is working to set up measures by which online brokers can voluntarily regulate their operations without having the visible foot of government slowing the train. And with the highly publicized tragedies of day-traders committing crimes after trading losses, it's important to draw the distinction between such incidents and the vast numbers of investors who are empowered by online access.
There are quite a few cars running on the electronic roller coaster now. We evaluated 27 of the Internet-based trading sites, plus two additional brokers aimed at the buy-and-hold investor (See story). The brokers we've rated include the top 15 in terms of market share, plus an additional 10 that our readers indicated were of interest. We looked at the brokers from the customer's point of view, executing trades and examining the reports and amenities available. Our sincere thanks go to the approximately 300 readers who responded to our queries about online brokerage experiences. You provided a great deal of food for thought, and gave us ideas of what you really want.
Our focus is on the Internet-based services in this review; in the future, Barron's will take a look at services such as CyBerBroker, TradeCast and Watley Ultimate Trader, which use an Internet connection but one that links them directly to a broker's computers. These services are aimed at more frequent traders. Even though we closely examined the offerings of 27 online brokers, there are about three times that many that we couldn't cover in this article. Of the 27 we examined, there are only three near the bottom of the list that we would actually avoid, a testament to the overall quality of the offerings this year.
Although our roller coaster does occasionally jerk to a stop and remains motionless before starting up again, most online brokers have greatly improved site design and access to research and have provided other creature comforts.
In our study, we developed a profile of a typical Barron's reader and looked at the services through that individual's eyes. Our focus was on benefits for holders with substantial portfolios -- over $100,000 in assets -- who make three round-trip trades per month.
Our readers told us what features would induce them to switch to a different broker. Among them were the ability to specify a particular lot of stock when placing a sell order, and better tracking of cost basis and capital gains, all key features to minimize the tax bite of profitable investing. A frequent complaint was the inability to get in on initial public offerings, even if the client had an account larger than $1 million. Several readers commented that they'd be willing to transfer significant assets if they knew they had access to IPOs more often.
Several wealthy readers expressed dismay at broker policies that limit amenities to frequent traders. Reader Mary Harada comments, "I think we should be entitled to the same bells and whistles as investors with significantly fewer resources who are seeking the Holy Grail of instant riches via account churning." Brokers, please copy.
Customer service isn't used very often, but it had better be good when Barron's readers need it. This year, quite a few brokers (National Discount Brokers, AB Watley and Datek among them) added a "chat with a sales associate" function to their offerings. Click on a button and a chat window opens that lets you talk directly to an associate without tying up another phone line or sitting on hold for a half-hour.
We maintained our rating system from last year, which gives additional weight to the trade experience and to the site's reliability and range of offerings, while decreasing the weight assigned to the commissions charged. We changed the way we rate commissions, in an attempt to take into effect the variety of pricing schemes introduced this year. We have yet to find a five-star broker, at least one that lives up to our high standards.
And now for the envelope, please.
As in years past, nobody's perfect, but three brokers earned four stars. National Discount Brokers came out on top by a hair, mostly owing to its superior trading screens. Last year's champion, DLJdirect, and newcomer Merrill Lynch Direct also earned four stars, primarily thanks to the research and reports they supply.
Seven brokerages earned an admirable score of 3 1/2 stars: American Express, AB Watley's Watley Trader, Morgan Stanley Dean Witter, E*Trade, Muriel Siebert's Siebernet, Charles Schwab and Wall Street Electronica. Each of these sites has strengths that will appeal to knowledgeable investors, but each has a drawback or two that keeps it out of the top tier.
Like Diogenes, who searched in vain for an honest man, we're still searching for the perfect online broker. We'd like to see the order-entry process streamlined, minimizing (or eliminating) the number of verification screens by utilizing field-by-field checking during data entry, while maximizing the amount of data available at the time of the trade. A real-time quote, presented before the order is entered, is essential.
Drop-down list boxes that eliminate the need to do a lot of typing are very helpful. For example, if the trader selects "Sell," there should be a drop-down box that contains the ticker symbols of securities in the account, thus avoiding data entry errors and inadvertent short sales. An easy-to-read verification screen that does more than just echo back the data entered is necessary. Finally, an instant link to the status of the order, followed by real-time updating of the trader's portfolio, is also key. Portfolio analysis reports, with links to news and research, as well as transaction history going back at least 90 days, are important features.
But before you rush off to open accounts at this year's four-star brokers, a caveat: Past winners have experienced difficulties as new customers flooded them with applications and transfers immediately after Barron's published its ratings. Our apologies, in advance, if that happens to you.
We ranked the brokers on a scale of 1-5, 5 being the highest, in five key areas:
Trade Execution Process: Our focus on the process of placing and confirming trades was inspired by feedback from our readers, who want to know the nitty-gritty that can't be ascertained by using a demo. A "5" in this category is given to brokers that provide a well-organized trading screen that offers a current real-time quote; drop-down boxes to help avoid data-entry errors, and error checks that don't stop you in your tracks. Confirmation reports that either pop up or are easy to find along with portfolio, position, and account-balance updates in real time also go into a "5" rating.
We executed equity trades on all 27 of the ranked brokers during market hours, performing a market buy and a limit sale of a Nasdaq stock. Following the purchase, we evaluated the execution and portfolio reports. After the limit sale, we looked at the open-order reports and looked at ways for the trader to follow the progress of the order. We also examined the mutual-fund and options-entry screens, though we didn't place orders there. A "5" in this category means the order-entry and execution process flowed easily from one step to the next, with real-time information available when needed. We added 25% to this score to emphasize its importance to Barron's readers.
Ease of Use: How easy was it to navigate around the site? Does the layout of the site make sense and minimize the number of mouse clicks it can take to get from one place to another? Sites that keep you a mouse click or two away from any other area get higher rankings than those that require navigation through an online obstacle course. A "5" in this category means the site was easy to use, well-designed, and doesn't bog down as a user moves from screen to screen.
Reliability and Range of Offerings: Was the site accessible every time we loaded it? Did the graphics snap onto the screen, or did they crawl? We looked at a variety of performance reports, including the Gomez Advisors report card, the Keynote Web Brokerage Index, and Don Johnson's discount brokerage ratings when considering this ranking. We also include the number of ways a broker can be reached in this calculation to indicate flexible methods of trading. Range of offerings describes what you can trade online: Almost all of the sites ranked offer equities, mutual funds, options and fixed-income securities now. A "5" in this category means the site was reliably accessible at reasonable speeds, and offered a wide range of tradable investments, and that a client could reach a live broker or make a touchtone telephone trade if desired. This score was also augmented by 25%.
Amenities: Can you get meaningful quotes, charts, news and analysis quickly, and view them on a well-laid-out screen? Is it easy to see how your holdings or other issues you're watching are performing? A "5" in this category means a broker has a wide variety of proprietary information, along with real-time quotes, available free for trading customers, or has links to data from other providers at no additional cost. This year we also took into account the tax-related reports provided on the site. Additional consideration was given for brokers who offer special benefits to clients with over $100,000 on account.
Commissions: What's the trade going to cost? We changed the way we rate commissions this year, calculating the cost of three round-trips -- market buys and limit sells -- for a customer with over $100,000 on account. A "5" in this category means the broker's total fees for the six trades was $50 or less. We reduced the weight of commissions in the overall ranking by 50% to reflect the waning emphasis on price.
Our Four-Star Trio is led by National Discount Brokers. This year's champ rolled out an augmented site in mid-1999, and keeps working at improving it. It's nowhere near being the biggest of online brokers, with approximately 200,000 accounts, or about 10% of E*Trade's customer base. For data-hungry investors, however, the trading screens are packed with information, and customers can have execution reports pop up over their browsers. We heartily approve of the real-time portfolio updates, and portfolio analysis reports that can keep the trader up to date on changes in asset values.
A feature many readers asked for -- access to tax records -- is available through NDB's Tax Center. Their "Schedule D-efense" allows a customer to download account history into an Excel spreadsheet, which is designed to make Schedule D calculations. There's not much proprietary research available from NDB, but the third-party collection they've put together is well organized and includes a Java-based charting application that features 11 technical indicators. NDB customers also can place trades via touchtone phone or live broker as well as on the Web.
Customers with over $1 million in assets at NDB are designated "concierge customers," and are offered a wide range of additional benefits including a dedicated help desk, access to IPOs, streaming Level II quotes and reduced margin rates. NDB also has perks for frequent traders, including the Active Traders' Advantage, with which you can make multiple trades in the same stock on the same side (all buys or all sells) for a single commission. The site is busy, but easy to navigate with the menu bar down the left side of the screen. It takes three clicks at most to get from one place to another in the site.
Cover Story, Part 2
Concierge customers and frequent traders are given access to NDB Select, which displays real-time Level II quotes, a quote grid display, lists of most active stocks for the day, and an execution report giving the time and price of transactions. News, real-time stock charts and tickers, and option quotes and analysis round out the NDB Select services.
On the downside, several Barron's readers complained that the site was difficult to load, but we didn't have any trouble gaining access over a 56K dial-up modem on numerous occasions during our month-long testing period. You can't trade bonds with NDB yet. In the last couple of weeks, NDB's site was hit with what they call "hacker-like" denial-of-service attacks, which the company claimed were probably caused by a software provider with whom they're involved in legal wrangling.
NDB is currently checking out smaller brokerages as acquisitions (who isn't these days?) but spokesman Gregg Sharenow says the broker is emphasizing technology rather than takeovers to gain clients. "We think we can attract customers at the right pace and for the right price, rather than paying $4,000-$5,000 per customer through acquisitions," he says. Watch for announcements of an alliance with one of CyBerBroker's competitors in the near term.
Last year's champion, DLJdirect, slipped a tad and ended in a tie with newcomer Merrill Lynch Direct. Neither offers a real-time quote on the trading screen until you get to the confirmation stage, which accounts for the score of 4 in the Trade Execution category, and both sites are somewhat more difficult to navigate than NDB's. But both sites excel in customer reports and in the range of services offered.
Merrill Lynch Direct clients have free access to numerous high-quality research reports, including Merrill's weekly Focus 1 stock recommendations and in-depth analysis of various industries and corporations as well as unlimited free real-time quotes. DLJdirect customers with over $100,000 in their accounts get free access to Donaldson Lufkin & Jenrette's research, though DLJdirect still doles out real-time quotes based on trading volume (100 quotes per trade). Both brokers offer a wide range of assets that can be traded online, though Merrill customers who want to trade bonds have to talk to a human to place an order.
When entering a trade on Merrill Lynch Direct, you're given the opportunity to read Merrill's research reports, if available, for the stock you're buying or selling. Merrill customers can opt for an Unlimited Advantage account, which involves an annual fee starting at $1,500 in exchange for no-commission trades and additional research. We boosted Merrill's Amenities rating a point from our December 9 Barron's Online review ("The Merrill Empire Strikes Back") once it finished augmenting the site, which bumped it up half a star and into the top-ranked trio.
Both DLJdirect and ML Direct give customers a wide variety of non-transaction-based services, such as credit cards, cash-management accounts, and online bill payment. DLJdirect's services are aimed at customers who like the feel and the range of services of a full-service broker, but would rather pay lower commissions.
Our next group of brokers all earned a respectable 3 1/2 stars, meaning they've got their good points but have some room for improvement.
American Express Brokerage, which was relaunched last November, added welcome improvements to its site. The most notable is that account holders with over $100,000 of assets with AmEx don't have to pay commissions on either the buy or the sell side. If you have $25,000$100,000, you won't have to pay commissions when buying, but $14.95 will be levied when you sell. American Express Financial Advisors' mutual-fund research is free to account holders, as are financial-planning applications and an equity evaluator.
Last year, we didn't even bother to include AmEx in our annual review because the site hadn't changed in two years, and its offerings were -- frankly -- lame. Now it's just a smidgen below the top tier, thanks mainly to the way we assign points for commissions. AmEx gets the full five points in the Commissions category since we made the calculation for a hypothetical customer with over $100,000 on account. But that counts less than any other criterion.
Signing up for an account with AmEx is a piece of cake. You can do it online, and once you're finished, you can make stock trades of up to $15,000 as long as you fund your account within three days. More online brokers should emulate AmEx's portfolio analysis reports and its easy-to-read account balance screen.
AB Watley's Watley Trader, its Web-based service, is surprisingly strong even though the company downplays it in favor of its Ultimate Trader service (which we'll look at in the near future). For just $9.95 per transaction, you get access to a well-designed trading screen that lacks only a real-time quote on the order-entry page. Though it doesn't offer proprietary research, there's free access to the usual suspects (Zacks, Briefing.com, Market Guide, etc.). Watley has big plans over the next six months to launch an upgraded trading platform that will include wireless applications.
Next up is Morgan Stanley Dean Witter, the former Discover Brokerage, which was formerly Lombard. Though it retains the ease of use of the Discover technology that helped put the site at the top of ratings two years ago, as well as amenities such as the Blue Chip Market Basket (with which you can purchase $5,000 or more of a "basket" of 10 stocks from the Dow 30 for a commission of $39.95), the fees have gone way up, reversing the trend established by just about everyone else in the industry. Discover clients have had a grace period that expires April 1.
The site has great research, and a long list of equities that are tradable online. But Barron's readers by the dozen complained loud and long about the increase in fees -- both for trading commissions and for research -- they're experiencing as Discover clients get assimilated into the MSDW fold. Few of them, apparently, are part-time tow-truck drivers who happen to own an island.
E*Trade, the original hands-off all-electronic online broker, more than tripled its transaction volume during 1999, thanks to its aggressive advertising and marketing and its wide range of services offered. The trading screen still needs error-checking and an online quote on the entry screen to gain in points. The amenities ranking was docked a point when we noticed that stock splits didn't track correctly in the portfolio analysis report.
That said, there's really nobody out there with the bond analysis and purchase features E*Trade offers, which helps its Reliability/Range of Services rating, but which are offset by the reports of frequent outages and slowdowns.
E*Trade's commission ranking suffers when taking into account the higher fee for limit orders. It offers access to IPOs, but customers complain about the limited windows open to indicate interest in a particular issue. Power E*Trade, offered to frequent traders, brings you real-time quotes and account balances as well as lower commissions.
Next up is market leader Charles Schwab, which rose a bit in the rankings this year, thanks to the enhancement and streamlining of the site. (See "Charles Schwab Is Getting There -- Finally," Barron's Online, March 2.) They added real-time quotes, via the Quick Quote box, to the trading screen, and have piles of research available as well as extensive financial-planning tools and investing-education resources. Schwab has about 25% of the online accounts signed up now, which means it still suffers the occasional capacity problems when the market is going crazy.
Schwab's biggest drawback still is its overnight updating of account positions and performance reports. Any trade is immediately reflected in the account-balance screen, but everything else is calculated as of the night before. Still, the recent improvements gave it an extra half-star.
But Schwab's loyal clients tell us they don't mind the high commissions in exchange for high-quality customer service.
Tied for the next spot on the list are two brokers that specialize in adding the personal touch to the online broker experience: Muriel Siebert and Wall Street Electronica. Both suffer from slightly less-than-stellar trading screens, and commissions that can skyrocket when you add on the per-share fee. For a large block trade, Siebert will assign a broker to shop it for you and get you the best price. Wall Street Electronica offers an interesting resource for financial advisers: the ability to manage accounts online while licensing their technology. Both brokers offer price improvement strategies, though they can slow down the execution of market orders since they are passed by a live broker.
At the middle of the pack were eight brokers, each receiving three stars. Datek and SureTrade, firms that appeal to frequent traders because of their low commissions, just missed getting 3 1/2 stars owing to weak portfolio -- analysis reports, though both have good trading screens.
Datek's order-entry process actually is one of the best in the group, with real-time quotes and execution reports that are quick and informative. You can get transaction reports going back three years on Datek's site. But its narrow range of services -- no options or bonds -- and lack of high-account balance benefits cost it some points.
SureTrade is a terrific value, offering both phone and live-broker trades as well as online, plus a good range of tradable assets. But numerous Barron's readers report problems dealing with customer service. Both brokers execute limit orders for under $10 a trade, and have links to helpful non-proprietary research offerings. For confident, self-directed investors who don't mind the occasional frustration with customer service, both of these sites are worth checking out.
Mydiscountbroker.com, Scottrade, TD Waterhouse and Web Street Securities wound up in a four-way tie for the next spot in line. Mydiscountbroker.com has the best trading screen, with real-time quotes and other up-to-the-minute information about your current positions.
Unlimited free real-time quotes are enjoyed by all Mydiscountbroker.com customers, along with real-time portfolio updates. The third-party research offered is thin, but that's a tradeoff acceptable for $12 commissions. The site's not pretty, and can look cluttered on a small monitor screen, but it shines when entering trades and tracking their execution. Keynote consistently rates Mydiscountbroker as one of the fastest in terms of access time as well.
Scottrade and TD Waterhouse ended up with identical ratings across the board. We were unable to review Scottrade for the prior two years, but this year we borrowed an account from a neighbor so we could head off the constant cries of "Why don't you rate my favorite broker?" from their customers. Well, Scottrade fans, the site provides just the basics for the equity and options trader. (The site was reviewed on Barron's Online July 15 in "So, What's the Big Deal About Scottrade?") The trading screen is sparse, and you don't get a real-time quote until you get to the confirmation screen.
One similarity between Scottrade and TD Waterhouse is their networks of live brokers, giving you a flesh-and-blood alternative to Web trading if you'd like. TD Waterhouse, by far the larger of the two, has a somewhat wider range of services but is termed a "problem broker" by Don Johnson's rating service, and garnered numerous "Never again!" comments from Barron's readers as well.
Web Street Securities dropped a star this year, only because it stayed the same while everyone else around upgraded significantly. The service has more than doubled its customer base in the last year, and quadrupled the transactions, which may be a factor in its relatively slow loading time. This was the only site we had trouble accessing during the month-long review process.
Still, if you like a lot to look at, Web Street gives you a live streaming ticker displaying the issues held in your portfolio. Account holders with more than $250,000 who make more than 25 trades per month qualify for Elite status and perks such as real-time streaming quotes (usually $29.95 per month), access to IPOs, and upgraded customer service. Live brokers are available 24 hours a day for Web Street customers, another nice perk.
Wall Street Access aims at high-asset clients, and says that its main ben |
