Online Investing vs. Traditional Financial Planners

Many individual investors are moving away from the more traditional broker and planner relationships of the past to self-directed online portfolios. This doesn't mean it's the right choice for everyone or that local planners no longer have anything valuable to offer, it only means that online investing is quickly becoming the most popular way for individual investors to manage their money.

Why is this happening? Partly because online brokerages are so easy to use. Even internet and investing novices can sign up, log on and start trading in less than an hour. This is very appealing to investors who would like to manage their own portfolio rather than going through a broker or planner every time they want to make a trade.

Another factor is that the internet is maturing rapidly. During the 80's and 90's the internet was transformed from a novel way to communicate and do business to the most powerful information sharing tool that the world has ever seen. As a result, there is more high-quality and inexpensive investing information available to the average investor than ever before. Investing research sites have also made huge strides over the last ten years. Beginning investors that are internet savvy can quickly learn to use investing research and analysis tools that are just as powerful as any used by investing professionals.

(Note: Local brokers are being pushed to offer more products and services to stay competitive. This means that even though financial planners still offer a wider array of services, the line between broker and financial planner is blurring. For simplicity's sake, we will use the term “planners” for the rest of this article to encompass both.)

Perception vs. Reality

Investors that switch from a local planner to an online brokerage, or vice versa, are sometimes disappointed because the actual experience doesn't match their expectations. Let's start by covering some common misperceptions to help you avoid this costly mistake.

Perception: You can't get the kind of high quality investing information you receive through your Financial Planner anywhere else.
Reality: This is definitely not true. You have access to tons of high-quality and inexpensive investment guidance if you need help making decisions (see our Can you afford outstanding investment advice? article for more on this subject). If you prefer to do your own research, you also have affordable access to investing research sites that provide tools as powerful as any used by professional investors (see our Morningstar.com: The Power of Institutional Investors at your fingertips article for more on this subject).

Perception: Local Financial Planners overcharge.
Reality: In general, yes, local planners do charge much more than an online brokerages but there are a few specialized services that they can provide at competitive prices. For example, if you have advanced estate, tax, and insurance planning questions, an hourly financial planner is a cost effective option. You'll also find that many online brokerages are not equipped to handle advanced planning needs.

Perception: Only a planner can help me with advanced topics such as estate, tax and insurance planning.
Reality: A few online brokerages offer these specialized services but unless you have a very large account ($500,000+), you will pay just as much for “managed account” services as you would for any local planner. Again, do your homework, an hourly planner will probably offer these advanced services at competitive rates and you will get the added benefit of a personal relationship and face-to-face interaction.

Perception: Online brokerages are always less expensive than local financial planners.
Reality: There are many expensive premium online brokerages that will charge you just as much or more than a local planner. Trading fees can vary anywhere from $1.50 to $75.00 per transaction at online brokerages so do your homework before you move your money. Our 2008 Online Brokerage Rankings are a good place to start comparing online brokerage expenses.

Perception: Only a local planner or broker can offer face-to-face interaction.
Reality: Strangely, many online brokerages now have local offices across the country if you'd rather ask your questions in person. However, every online brokerage we reviewed except for OptionsXpress charges you extra for broker assisted transactions so you will have given up the cost advantage of online trading if you trade through these local reps.

Perception: The premium you pay for a Financial Planner is a small price to pay for the outstanding investment advice, personal attention, and in-depth research they are providing.
Reality: Are you kidding? Investors aren't buying a custom suit, they should be focused on returns. Paying 12b-1 fees, transaction fees, redemption fees, loads and other fees for great service cuts a big chunk out of your profit. Also remember that local financial planners are constrained by client load, limited to investments in the fund families their company sells, and make a living by charging clients fees. It gets hard to justify paying a lot more for a local planner when you consider that none of these extra expenses we just listed improve the quality of the information they provide.

Personal Preferences and Investing Style

Another quick way to figure out if you should transition to an online brokerage is to evaluate your personal preferences and investing style. The questions below will tell you whether or not you share many traits in common with the typical online investor.

Do you understand the basic principles of investing?
Online investors prefer to manage their own portfolio. This means that they need to be familiar with and adhere to the basic principles of investing or they could lose a lot of money very quickly. See our 10 Basic Principles of Investing article for more information on this subject. If you don't feel ready to manage your own money responsibly, you may not be happy with the transition to an online brokerage.

Do you prefer to have complete control of your money or do you prefer a helping hand?
Online investors want the freedom to make their own choices and this is one of the major reasons why online investing appeals to them. Online brokerages give you complete control over your portfolio, you can avoid the hassle of always having to go through your planner to make a trade. You will decide what to buy and you will trade however and whenever you want. This appeals to self-directed investors but may be seen as a drawback for investors who prefer a lot of guidance and advice or don't like doing investing research.

Are you willing to learn to use your online brokerage's website?
Don't worry, this doesn't mean you need to be internet savvy, but you must be willing to learn. Many of the online investing sites, such as Scottrade, cater to beginning investors. Others, such as Schwab.com, offer special services such as a “New Client Concierge” to help beginners get acclimated. While most sites try to make it easy for newbies, there's no way around the fact that you will have to learn to use your site's investing tools and trading platform. If you don't have access to a high-speed connection or if you dislike using the internet, online brokerages may not be a good fit for you.

Do you have a clearly defined investing strategy?
All successful long-term online investors have developed a strategy that works for them. Even though you will likely try several strategies over the course of your investing career, it's important to have one in mind from day one. Why? Because it's very difficult to beat the market without a clear picture of your investment selection criteria, risk management plan and investment objectives. Before you transition to an online brokerage, choose and study a strategy that is in line with your investing goals and risk tolerance.

Ask the Tough Questions

Below are a few final tough questions that you should ask yourself, your financial planner and your online brokerage. If the transition to online investing still appeals to you after reading all three sections of this article, you can make your decision to invest online with confidence.

How disciplined are you?
After leaving your planner, you may still receive great investment advice through investing newsletters or through your own research, but none of that matters if you don't have the discipline to manage your own portfolio wisely. It will be up to you to make trades, stick to your risk management strategy and keep up with your allocation and diversification mix.

How much time do you have?
Saying time is money might sound cliche but it's very true when it comes to self-directed portfolios. If you don't devote enough time to your portfolio you will inevitably trail the market. This is a challenge for those of us that have to balance managing our portfolio with a full-time career and a family. If you are pressed for time but determined to manage your own portfolio, choose a passive strategy such as Index Investing.

Are you prepared to manage your portfolio for the next 5, 10, 20, or even 30 years?
Long-term investors win, short-term investors lose, and that isn't a theory, it's a fact. If you think you'll get bored of managing your own portfolio after a year or two, either stick with your planner or choose a passive strategy that will only require the occasional portfolio checkup.

Ask your planner to explain their strategy and show you how they are implementing it.
This is an important question since only 20% of professional money managers beat the market.

• Put together a list of your planner's recommendations. Did they outperform the market?
• Compare your broker's investments to the strategy he/she claims to follow. Are the recommendations in line with the strategy's selection criteria? For example, if your planner is a value investor, you'd expect to see low price-to-book ratios.
• Compare the planner's performance to broad and relevant indexes. For example, if your planner invested 50% of your money in international large cap stocks and 50% in domestic large cap stocks, the MSCI EAFE and S&P 500 would be great indexes to use as performance benchmarks.

Ask your planner how they will adjust their strategy over time as your investing goals mature.
As you get closer to retirement, your goals will likely change. You will become more concerned with capital preservation and income and less concerned with capital appreciation. Your planner should be able to clearly explain how he will modify your portfolio since he should already be doing that for other clients that are closer to retirement.

Ask your planner to provide a complete breakdown of the fees you've paid over the last two years.
This is a great test, it can tell you two important things about your planner. First, if they disclose every commission and fee, even the hard to dig out fees such as those paid out of a fund's 12b-1, they have earned some trust. Second, you are dealing with a pretty good money manager if your returns are beating the market after subtracting out all fees and expenses.

Since I provided a list of questions to help you decide when to leave your planner we thought it only fair to provide a list of questions that tell you when to stay. Does your planner outperform the market after fees and taxes are taken into consideration? Do they provide great diversification and broad asset allocation to maximize your returns while minimizing risk? Does your planner provide a complete financial plan including insurance, estate, retirement and tax planning? Do you receive occasional perks such as IPO shares or entry into top performing closed mutual funds? If you answered yes to all of these questions, you should think twice before leaving.

Ask your online brokerage, “What is your specialty?”
Most sites try to find a niche to be more competitive since there are so many online brokerages. For example, SoGoTrade doesn't have a full line of products and they don't have much in the way of research and analysis, but they do offer the lowest stock trade price in the industry at $1.50 per trade. For a list of popular brokerages and what they specialize in, visit our 2008 Online Brokerage Rankings.

Ask your online brokerage How dependable is your website?
You want a site that won't experience frequent glitches or crashes and that is relatively easy to navigate.

Ask your online brokerage Where can I find a list of all your trading costs and fees?
Fees vary widely.

I recommend you check out the online brokerage reviews for site specific expenses, but here are some rough guidelines for comparison purposes. The average online stock trade is around $9.99 and the average option trade is approximately $8.99 + $0.75 per contract. Other popular assets such as Bonds and treasuries most often trade on a per yield basis, which means that brokerages include the fee in the cost quoted rather than charging a flat amount. Rather than suggesting an average trade price for mutual funds, I suggest beginners look for a broker with 500+ no-fee no-load funds and 2,500+ no-load funds.

How good is your customer service and do you have specialists?
Customer service is especially important to new online investors.

What research and investing tools do you offer that set you apart from competitors?
It's hard for beginners to determine which tools are exceptional and which tools are generic. The easiest way to begin learning which tools have become industry standard and which are exceptional is to browse the Research & Investing Tools category in a few of our individual brokerage reviews. Overall, Ameritrade was 1st in this category since they offer so many of the industry's best 3rd party research and analysis tools for free but Fidelity came in a close 2nd as a result of cutting edge products like Wealth Lab Pro.

Perks and specials?
You will be amazed at the variety of perks and specials online brokerages offer to attract new clients and reward loyalty. A favorite is Vanguard's ultra-low cost Admiral Shares which can provide a significant boost to your long-term returns. Fidelity also offers some great perks. Any Fidelity client with > $50,000 is assigned their own personal financial advisor, a perk usually reserved for high net worth individuals.

Decision Time

This article conveyed the good, bad and ugly of online brokerages and traditional financials planners so that you could feel confident and comfortable with your decision.