Fees of Brokers That Discount Keep Dropping
The return of the individual investor to the stock market has been a boon for a lot of stocks--and also for the brokers who trade them.
Nobody knows that better than discount brokerages, which are riding high as many more do-it-yourself investors hunt for the cheapest way to make a trade.
Los Angeles-based Pacific Brokerage Services, a 16-year-old discounter, saw its trading volume rocket from 257,595 transactions in 1989 to 431,384 last year.
This year, PBS’ owner, Steven Wallace, says his firm is on a pace to do more than 650,000 trades. PBS’ success obviously isn’t small potatoes: Wallace is building a 22,000-square-foot home near the Playboy Mansion in Holmby Hills.
PBS is something of a model for the industry, where profits depend mostly on a firm’s ability to operate a bare-bones business while assuring clients a low price and a decent execution for whatever it is they’re buying or selling--stocks, bonds, option contracts, etc.
Discounters don’t offer the investment advice or money-management services of full-service brokerages; most are merely order takers for investors who know exactly what they want--and who relish paying as little as one- tenth the commissions charged by full-service brokers.
Discounters’ popularity has boomed as individual investors’ savvy has grown. Last year discounters handled an estimated 24% of all individual-investor trades, versus just 12% in 1983, says Marc Coler, a New York-based financial consultant who periodically surveys the industry.
But even as discounters’ investor audience has grown, so too has competition within the industry. Now, the intensity of that competition is forcing many discounters to make a choice: Go deep -discount to protect market share, or add new services or features to differentiate a firm from the rest of the pack.
The biggest discount firms are taking the latter route. San Francisco-based Charles Schwab & Co., for example, carved its niche in the 1970s on price competition alone. But today, as the nation’s biggest discounter, Schwab makes no attempt to be the lowest-cost provider.
Instead, the firm emphasizes service--including 24-hour access, walk-in offices and a reference program for investors trying to find a financial planner.
And this summer, Schwab may take a giant--and potentially risky--leap into financial counseling: The firm is developing a program that may allow some of its branch-office employees to help customers pick specific mutual funds for their portfolios.
John Philip Coghlan, a Schwab senior vice president, says the new service would be aimed at those who want to invest via mutual funds but aren’t sure how to choose from among the more than 3,000 stock and bond funds available.
Schwab personnel wouldn’t make the choice for a customer, Coghlan cautions. Rather, the reps would help a customer narrow the choices based on investment goals.
“The customer would make the final decision,” Coghlan says. Schwab would then charge a fee to buy the funds for the customer.
Certainly, the Schwab program would further blur the lines between itself and full-service brokers. And there’s no guarantee that the concept would be profitable. “You’d need this to be an under-45-minute conversation” between rep and customer, Coghlan concedes.
But when Schwab looks at its options for long-term growth, the millions of potential mutual fund customers are a logical market to mine, Coghlan says.
Most smaller discounters lack the capital that Schwab can throw at new ventures. For these firms, price remains the key competitive weapon. And the fight is getting bloodier, to customers’ delight.
Jack White of San Diego-based discounter Jack White & Co. took the deep-discount route in February. White cut his commissions up to 50% to get his prices closer to the industry’s lows.
White admits that he was losing customers to PBS, Beverly Hills-based Kennedy, Cabot & Co. and other deep-discounters.
He figured that there was no future for a discounter that tried to stay in the middle--that is, between the deep-discounters and the handful of very large discount firms, such as Schwab and Quick & Reilly.
“The middle guys are in the food chain now--they’re going to be gobbled up,” White asserts.
Coler, whose firm (Mercer Inc.) last surveyed the discount industry in the fall of 1991, says the results showed that “the deep-discounters are lower than ever.”
In Coler’s 1985 survey, for example, PBS’ commission to buy 1,000 shares at $30 each was $78. In the 1991 survey, the rate was $70.
Not surprisingly, Coler adds, “the deep-discounters have seen the greatest increase in revenues” within the discount business.
How low do they go? That varies, depending on the size of the trade. But in Coler’s latest survey, Wallace’s PBS consistently showed some of the lowest rates in the industry, often at $25 per trade.
To buy 200 shares of a stock trading for $30, for example, Coler says the typical full-service brokerage (such as a Merrill Lynch or Shearson Lehman) would charge $151. At PBS, the cost would be $25; at Jack White, $39.
Meanwhile, Schwab would charge $96--four times PBS’ rate, though still a 36% discount from the full-service brokerage charge.
Can deep-discount rates get much cheaper? PBS’ Wallace, a no-nonsense ex-Marine, figures that prices are about as low as they can go. But having said that, he also admits that he recently launched a new arm of PBS called Security Brokerage Services Inc., which is doing business via telephone in a handful of key states, including California and New York.
Security Brokerage’s fee is 2 cents a share, with a minimum commission of $25 per trade. The firm aims itself at active traders, Wallace says. It was a direct response to other deep-discounters, such as New York-based K. Aufhauser & Co., which Wallace concedes have been taking some PBS customers with ads touting commissions of just $24.99 per trade.
Is that gimmickry? Maybe. But the reality of the business, says Wallace, is that “customers are very, very cost-conscious”--and the discounters keep managing to rise--or is it fall?--to the challenge.
Why Discounters Are Hot
How commission rates vary between full-service brokerages and four discount firms, for three hypothetical trades.
Their Prices Are Cheap . . . So Market Share Grows
Transaction Cost for: Number of Shares/Price
1,000 at $5 200 at $30 300 at $50 Typical full-service firm $148 $151 $284 Pacific Brokerage Services $53 $25 $25 Jack White & Co. $63 $39 $42 Charles Schwab & Co. $90 $96 $127 Quick & Reilly Inc. $61 $65 $97
Source: Mercer Inc.
