You may think that choosing a broker is a difficult task and you are not wrong. There are so many products you can trade and even more brokers to pick from. Some are cheap, others are expensive, they seem the same and yet they are different.
This is not a review, instead we’ll go through the decisions you need to make before you fund an account. I’ll use the framework in the picture below to go through the selection process:
The broker’s product range
There are other tradeable securities which are more complicated than stock so you may want to get some experience before you jump in. However, you’ll need a suitable broker if you decide to try them later on.
Exchange traded products
These are options, futures and options on futures. As the name suggests futures allow you to speculate on the price of indices and commodities.
Options can complement your shares by setting purchase and sale prices or as a standalone product.
All of these instruments are well regulated as per the rules of the relevant exchange. Therefore, while the risk profile is different the transaction itself is as secure as stock.
On a side note, cryptocurrencies are also traded on exchanges. However, these marketplaces are not comparable to the London Stock Exchange.
Over the counter derivatives
CFDs and Forex provide easy access to derivatives and short selling with little capital. They are leveraged products and behave differently than stock.
The contrast with their exchange traded counterparts is the security of the transaction.
You probably know why you want to invest. If you’re thinking about managing your pension you need to look into a SIPP. But before you get started consider whether or not you need an IFA or wealth management.
A short time horizon will make a SIPP unworkable for you. Therefore, you may decide to pick an ISA. It’s tax efficient if you anticipate that trading profits will exceed your capital gains allowance. Otherwise, any cash account will do.
It gets more complicated if you decide to trade. Then you need to choose products or if you want all of them you’ll need a margin account. This type has qualifying requirements so you could end up with some restrictions.
Choosing your broker
You have to check if the broker is registered with the Financial Conduct Authority (FCA) and is part of the Financial Services Compensation Scheme (FSCS) before you even think of clicking on the sign-up button. There’s no point in risking it with an unregulated firm.
I assume that you’ve picked your product and account type by now. I guess that most readers will be looking at a SIPP or an ISA or both.
Whatever the case you are relatively safe if the broker is included in the FSCS. The problem is that the scheme covers up to £85,000. Your account may have already exceeded that or do so in the future.
You could split the money in a few institutions because the FSCS covers £85k per firm. The companies should have a separate FRN or authorisation number if you need to claim for multiple brokers.
Smaller accounts are in luck because they can be opened with any firm participating in the scheme.
I doubt that you’ll be day trading in your SIPP, you’ll just buy and sell some stock from time to time. Conversely, you can trade as much as you want in an ISA.
There’s no rule preventing you from having a SIPP, an ISA, a cash and a margin account. It’s another matter if you want to keep track of all 4.
The most important implication of trading frequency is on the fees you pay. It’s the one certain thing in the world of investing: you’ll pay for the transactions.
Some fintech firms offer free share dealing. Of course, they make some money from the bid-ask spread. I don’t think that this is a fee. There is always a bid-ask spread and there’s someone who collects it. What difference does it make if it’s the broker, a market maker or a high-frequency trading algorithm?
Free brokers may have inactivity fees or withdraw fees. Check their website prior to funding an account to ensure you’re happy with the terms.
There are services, like a SIPP, which can’t be funded by a bid-ask spread because customers don’t trade as often. Therefore, the brokerage will charge you an annual maintenance fee, something like 0.5%, 1%, 1.5% or 2%.
You may think that paying a bit more is worth it for one reason or another. However, I would like to show you a numerical example so that you can make your choice with some figures in mind.
How much money will your SIPP make for 10 years if the annual return is 7%, you contribute an initial £1000 and then £1000 per year. We’ll use an annuity formula to calculate the future value (FV):
FV = (1,000 + 1,000/0.07) x (1 + 0.07)^10 – 1,000/0.07 = £15,783
Now we’ll discount it for a fee of 1.5%:
FV = [1,000 + 1,000/(0.07-0.015)] x (1 + 0.07-0.015)^10 – 1,000/(0.07-0.015) = £14,583
The charges work out at 7.6% of the account value. Let’s try with 0.5%:
FV = [1,000 + 1,000/(0.07-0.005)] x (1 + 0.07-0.005)^10 – 1,000/(0.07-0.005) = £15,371
This time it’s 2.6% of the account. It seems like a good idea to think about the fees when picking the broker.
You may incur transaction fees on top of the platform fees.
The easiest way to start off is by looking at your account size. A bigger account will be suitable for large batches of shares so even a £12 fee may be fine.
However, it can turn into a problem if you start day trading for example. This will be an ideal time to look into transaction cost reduction. Before you do that call your broker, you may get a discount.
Fees are one of the most important issues as far as a small account is concerned. You can’t afford a £10 dealing charge if you have £1,000. It has to be a free or low cost broker.
I already talked about mobile apps. However, this is not the only service you are going to use. There will be a website, funding process, customer service, maybe even desktop software.
Brokers have other services like real time data, access to products and research. One way or the other you’ll pay for the technology so you have to pick a company which offers the things you need.
What do you want to have access to? You’ll need a more advanced broker if you want to buy Russian bonds for example.
In most cases the cheaper brokers provide access to less products, although the selection exceeds 1000+. This is perfectly fine because you’ll find shares of all the popular companies. Such a firm may become a pain if you want to trade penny stocks or advanced products.
An upscale broker will give you something like 25,000 – 30,000 different securities to play around with. You have to ask yourself Do I need all of that considering the cost?
What kind of information do you use? Sophisticated brokers provide analysis including financial model outputs, analyst ratings and extensive company information. All of this on the same platform, very convenient!
The free ones may or may not have some basic financial data. You won’t suffer if you are doing your own research anyway.
If you’re not sure what’s best for you check what services are available or start off with a small account at a free broker until you figure out what you need. There are demo accounts too if you want to try the broker without commitment of capital.
Some like an iPhone, others prefer Android. There are no right or wrong choices. Two people can have opposing views on a given app or website.
There is no sure way to know if you’ll like the brokerage platform. I normally make a demo account or watch a video to find out if it suits me.
One thing that you can compare is order execution. Where does your order go and when?
There are free firms which route orders at set times during the day so you won’t get the screen price. This is a huge issue for me, purely on principle. However, if you’re investing for years to come a few hours won’t matter.
Multiple and specialist brokers
Sometimes you just can’t have everything you want under one roof. That’s fine, you can open a few accounts to invest the way you want.
Problems like this occur when you want to trade different products. You can find firms which offer a variety account types: SIPPs, ISAs, share dealing, CFD and Forex.
However, these companies won’t be enough if you want to trade futures, options or cryptocurrency or if you need an account denominated in a foreign currency.
The broker selection process is relatively simple. You start with the products and account type you want. Then you choose the firm based on the account size, trading frequency and broker technology.
It will be more complicated to figure out your long term needs. The most important part is to make sure your money is safe. So check that the firm is registered with the FCA and covered by the FSCS. Consider splitting the money in separate firms if you have more than £85,000.
Shares and CFDs will give you the easiest access to the market. If you want to trade the latter you may want to have experience with stock first. This will help you develop market awareness.
Sometimes it’s just not enough and you may move on to options and futures. That’s another situation when you may benefit from having multiple accounts.