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Lessons Learned from Discount Brokers

posted on:  10/2/2006      revised: 3/9/2010

 

Does $3 per trade really make much of a difference?  Is it true that there are no coincidences in life?

I recently changed my primary discount brokerage custodian from TD Ameritrade to Scottrade. I am not affiliated, contracted or obligated with any investment brokerage firm but I used to simply choose choose different brokerage firms for different transactions and situations. The choice of brokerage firm makes no difference to my income or my practice. But over time, one or two brokers seem to have risen to the top of the pack and become almost a business partner and part of my daily life.

A few years ago Ameritrade was the brokerage firm to follow. They seemed to be doing everything right. Shortly after becoming a customer, I bought their stock (AMTD) and make a substantial profit as the price rose from about $8 to $18. I reluctantly sold the stock in December 2005. At the time, I was excited by the company's plans to expand the firm with momentum gained under the recent merger with TD Waterhouse. I also liked the fact that the CEO Tom Bradley was willing to give out his cell phone number to help advisers with important problems. (This was in part personal vanity simply because I give out my cell phone number as an integral part of my business plan but of course there is no operations comparison of my one person business with their much larger corporate structure). The firm announced bold plans for being bigger, better, brighter and took direct aim at investment giant Merrill Lynch. When they raises their commission by a few dollars by a few dollars per trade, I did not think that anyone would care. Apparently other investors were not so excited by the plans. Of course, I did not know that the Ameritrade stock was about to take a significant tumble. But within the next few months AMTD had lost 30% of its value. The stock recovered with the market in the fall of 2006, but has yet to reach its adjusted pre-merger price.

Meanwhile, I had always dismissed Scottrade as an "also ran". There was nothing wrong without he company, but nothing to write home about. The firm seemed to have no distinguishing characteristics and were just one of a few cheap discount brokers. I wondered about the ability of a "small" private firm like this to raise the capital necessary to compete in today's technology-based market.

Scottrade offers investment trades at $7, compared to $10 at TD Ameritrade. Investors with thousands of dollars to invest certainly would consider the quality of execution that TD Ameritrade boasts to be worth at least $3, right? Apparently not.

By the late spring of 2006 the tide had clearly turned. Holes were beginning to show in the TD Ameritrade business strategy that was retooled to increase profitability. Scottrade gained market share while TD Ameritrade lost investors. One headline pointed out that TD Ameritrade had captured favorable media attention but lost investors. Scottrade remained simply the lowest cost discount broker and began to grow faster. In the brokerage business, size matters. So does momentum, especially when it comes to growing a business. And apparently $3 per trade difference does make a difference to investors.

TD Ameritrade then decided to deny Web site access to hourly based investment advisers who did not actively manage assets. It did not seem to make sense, considering the cost of that service vs. the value of the investment assets that independent advisers refer to brokerage firms. Scottrade noticed the trend, and jumped on the opportunity to welcome the disparaged advisers.

In the end, TD Ameritrade became a great full service brokerage form, going in the direction of Schwab and Merrill Lynch. These two firms offer two different approaches to professional investment service for those clients who want to pay for it. These firms do not compete on cost. Over a period of less than nine months, Scottrade became the nation's best "no frills" discount broker simply by sticking to the same core business plan.

I notice that this business lesson comes at a time when my own business Freedom Benefits is competing against larger firms that are moving toward providing more services, but at a higher price. Freedom Benefits' strategy is simply to offer the nation's lowest priced medical insurance with free live support. Low cost medical insurance is not a very profitable business and so we must rely primarily on word-of-mouth from customers for growth. This is often not very effective compared to the multi-million advertising budgets of the competitors. The best hope it that Freedom Benefits will remain standing as the lowest cost provider while the others evolve their business strategies.

 

keywords:   discount broker investment Freedom Benefits low cost medical insurance

 

related topics:  "Comparison of Discount Brokerage Costs"

 

 

 

 

 


Copyright 2010 by Tony Novak. Originally produced and published for the "AskTony" column syndication prior to 2007. Edited and independently republished by the author in March 2010. All rights reserved.