A new day dawns for online brokers

Online brokers like to play down the importance of fees to clients, and yet two big firms have just made some significant price cuts for people trading stocks and bonds.

Both moves sharpen the cost advantage of do-it-yourself investing, but there's more to them than that. They also highlight the continuing evolution of online brokers from a tool for active stock traders into a mainstream investing channel that you can access without a big portfolio or encyclopedic knowledge of the market.

If you've been thinking of taking control of some or all your investments, now is absolutely the time. (Or, better, wait until Nov. 10, when my annual ranking of online brokers will be published.)

In terms of its impact on overall trading costs, the big news this week is that industry leader TD Waterhouse will, on Nov. 4, make $9.99 online stock trades available to clients with as little as $50,000 in an account, down from a previous threshold of $100,000.

Multiple accounts within the same household can be grouped together to qualify for the discount, which means a lot of people will no longer have to pay a $29 minimum to buy or sell stocks online.

A more revolutionary - and long overdue - price cut affects clients of Scotia iTrade who invest in bonds. The firm has dispensed with the practice of burying commissions in the prices quoted to clients who buy or sell bonds and will now simply charge a flat fee of $1 per $1,000 in face value of bonds being traded. The minimum fee will be $19.99, the maximum $250.

Online investing is based on the idea that if you make your own decisions, you should pay less than someone who receives advice. Commissions for stocks and mutual funds certainly reflect this, but bonds have quietly remained an exception. A few years ago, the former bond chief at one of the country's largest mutual fund companies contacted me to say how aghast he was at the cost of trading bonds through an online broker.

The problem starts with a lack of transparency. When you buy a stock, you can see the price at which it last traded, the price buyers are willing to pay and the price sellers are asking. Investing in bonds with an online broker is like buying milk - a price is quoted, and that's that.

Folded into that price is a markup to ensure your broker makes a profit on the transaction. You won't see that markup because it's buried in the quoted price. And yet, it's crucial information because every extra dollar you pay for a bond has the effect of squeezing the yield lower.

Scotia iTrade's so-called Buck A Bond pricing will only work if clients can be confident they're paying a wholesale, pre-markup price for bonds, and then a flat commission. (In a coming Portfolio Strategy, I'll compare bond prices at Scotia iTrade and other firms to document the firm's price advantage.)

Stock jocks may scoff at a move to make bonds more cost effective for investors, but they're no longer the primary market for online brokers. "You have the hard-core active trader, but you also have the mainstream customer who is trying to take more control of their finances," said Bob Grant, managing director for online brokerage at Bank of Nova Scotia.

Explanatory videos and pop-up boxes have been introduced online to help new mainstream clients, and many firms are making the live seminars they offer clients available online. The online brokerage industry's commission structure is also becoming more accommodative to the mainstream client.

Cheap commissions used to be reserved for active traders at the big bank-owned firms, and then later for clients with $100,000 in total account assets. Smaller, less active accounts paid a minimum $29 per online trade. Exceptions to these rules have included Scotia iTrade, which has long offered a sub-$10 trade for accounts of $50,000-plus, as well as smaller independents like Questrade and Virtual Brokers that charge as little as $4.95 for all customers.

TD's new pricing is designed in part to help clients who have seen some erosion in accounts that used to be in the six-figure range. But it's also an enticement to mainstream investors who don't have mega-sized accounts.

"We're seeing a growing profile of self-directed investors who are getting into the market at smaller asset levels," said John See, president of TD Waterhouse Discount Brokerage. "Smaller accounts can potentially grow into larger accounts."

Mr. See said lower commissions may also remove the reluctance people have to trade at a price level where a sell and a buy transaction together could cost $58. Certainly, there's the potential for investors to hurt themselves with more frequent trading. But cheaper fees also clear the way for savvier investing through periodic rebalancing (trim winners, add to losers and get back to your proper mix of assets).

Note that TD's lower commissions are available only to clients who sign up to receive account documents online instead of through the mail. About 80 per cent of these slips are distributed online already.

If you spend much time on financial websites, you'll know that TD Ameritrade, Toronto-Dominion Bank's U.S. online brokerage division, charges $9.99 to all clients for online trades. Don't be shocked, but Mr. See said TD Waterhouse isn't about to follow.

"We have higher overall costs in Canada," he said. "In general, exchange and data fees are higher than in the U.S."

If you're thinking about making a move into online trading, the new trend toward lower pricing adds to an already strong price advantage for do-it-yourself investing. You should also know that brokers see many clients bringing over part of their holdings and leaving some with an adviser.

It makes good sense to retain an adviser who provides full financial planning, something that most self-directed investors probably aren't getting. If you have a mutual fund salesman for an adviser and want to take over your own portfolio, an online broker is an ideal replacement.

Follow me on Facebook. I'm at Rob Carrick - Personal Finance