Forward Diary

Stocks & Shares - How to choose a broker

When looking for a suitable stockbroker the logical place to start is your investment objective. Whether you are saving for a holiday of a lifetime, the deposit for a house, education fees or retirement, will make a big difference to the sort of service you need.  It is hard to think of a more critical financial decision than how you will pay for your child’s education, or achieve a decent pension. In these complex areas there is a strong argument for some kind of advisory relationship. Otherwise it is a case of looking for a suitable execution-only facility. The next step is to decide on the most appropriate type of account. For most investors the obvious starting point is an Individual Savings Account (Isa), unless you are saving for a pension when a Self-Invested Personal Pension (Sipp) may be the better option. Those with more of a trading mentality might prefer a standard dealing account or possibly a spot foreign exchange (forex) account with a specialist currency broker.  It is then a case of thinking about where you will be investing your money. If you do not want to get too actively involved in the process you will probably want to concentrate on professionally managed funds, whereas those who enjoy the hands-on approach are likely to be more interested in company shares or possibly leveraged tools such as covered warrants.     1. Selecting the right service for you   Advice  Those who want professional investment advice will need to choose a broker that offers discretionary and advisory portfolio management services.  These sorts of services start with a fact-finding session so the broker is clear about what you are trying to achieve and how much risk you are willing to take with your capital. It is then a case of deciding whether you would rather have  •  a discretionary arrangement, where you hand over all the day-to-day management of your portfolio, or •  an advisory service that provides recommendations but leaves it up to you whether to accept them.  Advisory and discretionary accounts are more expensive than an execution-only service, but the idea is enhanced performance more than makes up for the extra cost.  Execution-only services  If you prefer to make your own investment decisions you will need to find a suitable execution-only service. The starting point with these is the cost, but there are also lots of other features that may be relevant. These depend on the type of account and where you want to invest and are covered in the second and third sections of this guide.  Each time you buy or sell company shares, an investment trust or exchange-traded fund (ETF), you will have to pay commission on the transaction. Online deals tend to be cheaper with a typical flat rate charge in the region of £10 to £15. A few brokers apply tiered levels of commission according to the size of the trade, although this is more common for telephone deals.  Most brokers also charge a quarterly or annual administration fee. These are usually set at a fixed rate, but in some cases are calculated as a percentage of the value of your portfolio. Otherwise there may be an inactivity fee that applies if you do not trade for a stipulated period of time.  The only way you can work out how much the different services will cost is to estimate how many times you are likely to trade. In some cases there are discounts for frequent traders, although the criteria vary enormously between providers. If you plan to keep a lot of money in cash you should also find out whether it will earn any interest.    Multiple accounts  Having all your investments in one place makes it easier to monitor your overall portfolio, especially as many brokers provide a consolidated view across multiple accounts. It may also work out cheaper as some firms only charge a single admin fee.  The counter argument is that one particular broker is likely to be better in certain areas than others and if something was to go wrong you would be heavily over exposed. The main danger is your provider goes bust and is unable able to return its clients’ assets. In this worst case scenario you would be covered by the Financial Services Compensation Scheme up to a maximum of £50,000 for investments and £85,000 for deposits.  Even if you have more than this you should still be protected as most brokers hold their client assets in a nominee account. These operate a bit like a trust and a third-party custodian acts the legal owner on behalf of the beneficial interest of the investor.  If your broker was to become insolvent they would have no recourse to these assets and you should get them back, although it could take some time and you would not be able to trade. If the nominee accounts are pooled and there is a shortfall due to fraud you may incur part of the loss.  Anyone concerned about this remote possibility should speak to their broker to clarify the situation. If you are still worried then you should spread your assets between different providers.   2. Choosing the most appropriate account   Individual Savings Accounts  For most investors the best place to start is a stocks and shares Isa, as any income and gains would then be tax-free. These operate like a normal trading account and allow you to buy and sell a wide range of permitted investments including UK and overseas shares, managed funds and ETFs. The main limitation is that you can only pay in a maximum of £11,280 for the 2012-13 tax year.  You can change the investments within your Isa whenever you want and if you are unhappy with your provider you can move the account from one broker to another. Withdrawals can be made at any time, but if the money is later put back it will count towards the annual limit.  When choosing a provider the two main variables are the range of assets and the cost. Some brokers offer a more restricted selection of investments in order to simplify the product, whereas others cover everything and charge accordingly.  There are three key areas that all consumers should consider when thinking about investing in a Stocks & Shares Isa. They are:  •  price •  investment choice •  service  The Financial Service Authority’s (FSA) Retail Distribution Review (RDR) will require all providers to fully disclose their charging structures. At the moment a number of companies are retaining cash rebates from the fund managers to cover their costs. This practice will be banned from the start of 2014 under RDR.   Self-Invested Personal Pensions The most tax-efficient option if you are saving for retirement is to open a Sipp. These provide access to many different types of investments, but like other forms of pensions there are restrictions on when and how you can withdraw your money. There is tax relief on the contributions of up to £50,000 a year or 100% of your salary, whichever is the lower.  A Sipp separates the legal structure and administration from the investment management, but no two products are exactly the same in terms of the services and fees. The best way to find a suitable account is to think about what sort of investment and retirement options you are interested in and then shop around accordingly.  At the top end of the scale are the true, bespoke or full-service Sipps. These provide the maximum investment flexibility permitted under HM Revenue & Customs (HMRC) rules, with some of the more esoteric options being commercial property, land, hedge funds, foreign currency and unquoted shares.  Bespoke Sipps are also the most expensive with an establishment fee and an annual management charge of several hundred pounds. These sorts of costs only tend to be worthwhile if you have a large pension fund of well over £100,000.  Most of the investment returns that accrue in your Sipp are free of capital gains tax and income tax. This means your portfolio can grow more quickly. The main exception is the 10% tax credit that is deducted from UK company dividends which cannot be reclaimed. There are also some withholding taxes that affect certain overseas investments.  The main limitation is you cannot access the money in your Sipp until you reach 55. After that it is largely up to you when and how you take your benefits, at which point there is normally the option to withdraw up to 25% of the accumulated capital as tax-free cash. Whatever is left over will then be used to provide a taxable income to fund your retirement.   Trading accounts  Those with more capital at their disposal or who want the maximum possible flexibility will need to open a separate trading account. There are no restrictions in terms of how much you can pay in or take out, but the cost and choice of investments differ from broker to broker and all the income and gains are taxable.   3. Deciding where to invest   Managed funds If you do not have the time or inclination to monitor your account on a day-to-day basis or have limited capital you will probably want to concentrate on managed funds such as unit trusts and open-ended investment companies (OEICS). These pool your resources with those of thousands of other investors and then allocate the cash across a number of different holdings.  The beauty of this sort of product is your money is professionally managed and this should in theory result in better long-term returns. There is also the diversification aspect as private investors would find it impossible to achieve such an effective portfolio when acting in isolation.  OEICS and unit trusts typically have an initial charge, which can be as much as 5% of your investment, but when you use a stockbroker this fee will frequently be fully discounted. This represents a valuable saving compared to buying direct from the investment manager.  There is also an annual management charge (AMC) that can be anything up to 1.75%. This is deducted from within the fund and will act as a drag on performance. Part of the reason it is so high is it includes trail commission paid by the fund manager back to the platform provider.    Investment trusts  The other main type of managed fund is an investment trust. These are structured as listed companies and have an independent board of directors who are responsible for appointing and overseeing the fund manager. There are around 400 from which to choose and between them this selection provides exposure to a wide range of different markets.  Investment trusts are closed-ended funds, as they have a set number of shares that they use to raise a fixed pool of capital that is then invested by the manager. Investors can buy or sell them on the London Stock Exchange (LSE) in exactly the same way as they would any other company shares. The price of an investment trust therefore varies according to both the performance of the underlying portfolio and also prevailing market sentiment. Unlike an OEIC the shares can trade at either a premium or discount to their net asset value (NAV).  Investment trusts are more complex than unit trusts and OEICS but these extra features can help them to deliver better performance. They also tend to be cheaper with the average AMC around 0.5% lower than for the equivalent unit trust. You will find all the details in the company research section of your broker’s website. Independent financial advisors (IFAs) have tended to shun investment trusts as they offer no commission stream. Under the new RDR regime, IFAs must outline all available options so investment trusts could be about to enjoy additional and deserved publicity.   Exchange-traded funds  The main alternative to investing in an actively managed fund is to buy a passive tracker instrument such as an ETF. These are designed to track an index but trade like a share and can be bought or sold during the day whenever the exchange that it is listed on is open for business. As a rough guide they tend to work out about 1% a year cheaper than an equivalent unit trust or OEIC, as there are no fund managers to pay and fewer expenses to meet.  There are now over 1,000 ETFs, ETCs and exchange-traded products (ETPs) listed on the LSE. Many more are available on international exchanges, especially in Europe and the USA. These include single country, regional and sector equity ETPs, as well as instruments linked to bonds, currencies, commodities, volatility and property. The idea is the ETF, ETC or ETP tracks the performance of the underlying index, commodity, sector or basket of assets as closely as possible. Investors sometimes use ETPs to provide cheap core holdings for their portfolio and then invest smaller amounts in managed funds in an effort to outperform the market. Another option is to try your hand at tactical asset allocation, where you use ETFs to specifically target undervalued areas. There is no initial charge with an ETF although you will have to pay commission at the same rate as when buying company shares. The AMC is normally less than 1% and in some cases it is only a few basis points. Most brokers provide details of the performance and links to the associated factsheets.   UK shares  Those who prefer to take a more active interest in their portfolio will probably want to invest in UK equities. This is a lot more involved than buying a managed fund as you have to identify the opportunities yourself and then decide how best to trade them.   The beauty of investing in individual stocks is you can tailor the portfolio to match your objectives and risk profile. If you have a particular area of expertise such as the technology sector or you only want to buy steady, high-yielding businesses like utilities you can act accordingly. This is arguably more risky but could ultimately result in a higher return.  All stockbrokers allow you to invest in UK company shares listed on the Main Market of the LSE. The smaller stocks that trade on the junior Alternative Investment Market do not qualify for an Isa so you would need a trading account or Sipp if you want to glean exposure to these fledgling and hopefully up-and-coming firms. In each case there is a 0.5% stamp duty payable on the purchase. When you invest in shares using your broker’s online platform you will normally be presented with the current market price and given a window of ten or 12 seconds in which to decide whether to go ahead and place your order. These systems automatically scan the various Retail Service Providers (RSPs) to ensure you get the best possible price available at the time. Normally this will result in a small improvement on what is being quoted by the exchange.  Each broker has a research section on its website that allows you to investigate potential investments that you might have read about in Shares or other trusted sources of research and ideas. Those with a particular company in mind can also check the latest news and directors’ deals, as well as the fundamental data, consensus analyst recommendations and charts, on such useful websites as,, and  Most firms offer handy features that can make it easier to manage your portfolio. The main one is a stop loss, which will automatically sell a holding if the price drops to a certain level. There are also trailing stops that you can use to lock in your profits while restricting your losses.  Active share investors may want mobile access to their account. Most brokers rely on smartphone-friendly versions of their websites, but if you have an iPhone you may prefer a bespoke app.    International shares  Once you have built up a UK share portfolio the next potential step is to diversify overseas. This would enable you to invest in some of the best-known companies in the world and to benefit from businesses operating in faster-growing economies. The coverage and cost varies enormously between different brokers so it is worth shopping around if you think you might want to use this aspect of the service.  There is no stamp duty when buying overseas shares, although investors will need to complete a W8-BEN form before they commit capital to the US equity market to ensure that they are not taxed twice. In some cases there may be other local tax issues but your broker or financial adviser should be able to help.  Most American companies report their earnings after the closing bell on the New York Stock Exchange. It is not normally possible to react to the news until the market opens at 9.30am local time the next day or 1.30pm GMT in the UK, by which time the price may have changed dramatically.     Covered warrants and structured products  More experienced investors may want to spice up their portfolio using covered warrants. These are securities issued by large financial institutions such as Goldman Sachs, RBS and Société Générale and they give you an option-like exposure.  There are around 400 covered warrants traded on the LSE and they are linked to a variety of different underlying assets including currencies, shares and indices. The high leverage means that even a small investment could have the potential to return a healthy profit, but they are risky as a lot of them expire worthless.  Investors who are bullish on a particular market could buy an out-of-the-money call, which would magnify the return if the underlying asset were to rise. Those who are bearish could achieve the same effect by buying a put.  There are also several hundred structured products. These range from simple trackers, to more complex strategies offering a geared exposure to upwards or downwards movements in prices. Full details of all these instruments are available from the issuers’ websites, but in each case you need to be aware of the counterparty risk. This ‘How to’ guide is produced by Shares Magazine and is only for general information and use, and is not intended to address particular requirements. The value of investments and the income derived from them can go down as well as up. Past performance is not necessarily a guide to future performance. You should get professional financial advice before making any investment decisions.


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