‘Discount Broker’ is the answer to high transaction costs plaguing the financial sector. A discount broker is a no-frill broker like a low cost airline. All the broker does is offer the platform for transaction and the services that are essential to complete a transaction, just like a low cost airline’s sole aim is to take you to your destination safely. The near rock bottom brokerage cost makes a lot of difference for a client. Research or stock calls these days are available in plenty on the internet or through newspapers, periodicals and websites. Then there are many paid newsletters and content providers who give trading and investing ideas. These are done at a fixed fee.
The difference between a discount broker and a full service broker is reflected by the transaction cost on low cost stocks or on options trading. Many brokerages charge a minimum amount for stocks below a particular price. Their aim is to protect their brokerage in absolute terms as low priced stock would give them minuscule brokerage if they are calculated in percentage terms. Similarly in options trading (which are generally low priced, especially out of the money options) many brokerages have a flat amount per contract. This method of calculating brokerage has a big impact on the profitability of the client).
Another advantage of the discount broker is that they are unbiased. Since they offer no advice, they will not make you sell a good stock or at the same time, make you buy one. They will not bother you with their research calls and remind you of all the trading calls that clicked while conveniently brushing recommendations under the carpet that did not perform.
Indian financial markets have undergone a drastic change for the good over the past decade. Electronic trading has not only brought transparency in a business that was notorious for opaqueness but has also brought down cost. Internet trading has taken the transparency and cost parameters to a completely new level. Internet trading has also brought in a set of brokers who offer rock bottom rates for transactions. They are called discount brokers in industry parlance.
A broker charges brokerage for offering a platform to transact. Traditional brokers charge higher brokerage because they claim to offer value addition by offering research calls. Though a traditional broker may sound benevolent by claiming that his “well researched” calls are produced by a huge team of highly educated and more importantly highly paid analysts with the sole aim of helping client increase wealth, the truth is somewhat different. A broker makes money only if a client transacts. And the more the client transacts, the more brokerage goes to the broker’s kitty. Brokers typically have varying rates of brokerage, depending on the client and the quantum of trading. For a high volume trader who normally churns his portfolio aggressively, brokerages are lower while a retail client ends up paying more.
Before you rush to open an account with a discount broker, remember to check if there are any hidden costs behind the low brokerages that are advertised. Also, check the infrastructure of the discount broker, his internet connectivity speed and more importantly if there is a standby mechanism in case either your internet or the broker’s connectivity is hampered.
For every transaction that takes place in the financial market, be it equities, commodities or foreign exchanges, there are various cost involved. All investors - whether they are financial institutions, insurance companies, high net worth individuals or retail investors incur these costs, irrespective of the size of their transactions. Some of these costs are statutory costs, like the ones levied by the government, stock exchanges or the market regulator SEBI while the second component of cost - brokerage depends on the broking house an investor selects and the relationship he enjoys with the broker. Further, there are also some statutory costs that are linked to the brokerage. In other words, higher the brokerage, higher will be these charges.
A client, especially retail one, is generally unaware of what to buy or what to sell. He is the one who depends on brokerage calls and pays a sizeable amount for it. Experts have often questioned the quality of research being churned by most research houses. The best example of this is the number of cases that were filed by clients against broking firms for their calls, post the sub-prime and Lehman crisis. If research is not the ‘value addition’ it is claimed to be, then why should one pay the high brokerage charge?
(Vikas Singhania is the Executive Director, Trade Smart Online a discount broking house)