What is a Brokerage?
Brokerages are intermediary firms that facilitate the buying and selling of financial securities, like stocks and bonds, on behalf of their clients.
They take a percentage fee of the translations as the service charge, but some can provide some services for free and make the financial service more accessible for almost anyone.
The most well-known example, and arguably the one who brought this business model, was USA based startup Robin Hood.
With zero fees for buying and selling stocks, Robin Hood made their app more attractive for people who had never tried any broker because of their fees and introduced millions of first-time users into the financial market. It has around 12 million active accounts.
Unlike Robin Hood or other new online brokers, which mostly targets new and low net-worth investors, doesn't have any minimum amount for buying and selling stocks, and have mostly zero service fee, the big-name brokers have a minimum investment amount that can be upwards of a hundred thousand dollars and charges hefty fees for there services.
Some big-name players in the industry are Vanguard, Charles Schwab, Fidelity, J.P Morgan, Bank of America/Merrill Lynch, etc.
“Brokerage firms have trillions of dollars under management and millions of active accounts, Vanguard alone has more than 8 trillion under management. At the same time, Charles Schwab and Fidelity combined more than 65 million active accounts.”
Source: The Largest Brokerage Firms in 2022 | The Motley Fool)
Types of Brokerage
Different types of brokerages cater to different types of clients and provide different investment products. Following are some examples:
1. Full-service brokerage
These offer various services, from investment research to account management. They have high fees for their services and mostly target investors with high net worth.
They provide their services for almost all investments like stocks, bonds, mutual funds, options, and more complex investments, which are generally unavailable to small investors.
2. Discount brokerage
They provide the most basic services and have a very small fee. They also provide some services for free and charge for additional services like margin and limited investment advice. These are mostly used by individual investors who like a more hands-on investment approach.
3. Online brokerage
They also function as discount brokerages but conduct all their operations online. As a result, they provide all the tools individuals need to trade online and charge little to no fees.
4. Specialty brokerage
They provide their service in a specific investment on the market. For instance, the brokerages that only provide options or forex trade.
5. Institutional Brokerage
These firms serve mostly institutional clients such as hedge funds, pension funds, mutual funds, and other large investors.
They provide services such as block trading, liquidity management, and research specifically tailored for institutional investors. Some of these also work as market makers as they have a large inventory of stocks and securities.
Note
A broker has to be registered with the country's financial market regulators before providing any services to the public.
Functions of a Brokerage
At a basic level, the function is to solve its client's problem for a fee. But as the financial industry changes and evolves, there are additions to the list of services they provide, and some services may not be required or become obsolete.
The following are some examples of these functions:
1. Investment Advice
They also provide investment advice to high-net-worth clients(HNI) or charge fees.
Most of the big firms have separate teams to provide this service. They provide recommendations on securities to buy or sell, market research, and guidance on investment strategies. In addition, they give advice tailored to the needs of their client.
2. Account Management
Some also provide the service of account management, where they actively manage the client's portfolios. This can include monitoring the portfolio's performance, rebalancing the portfolio, and making any necessary changes that align with client objectives and risk tolerance.
3. Custody of Securities
They hold the securities on behalf of clients in their custody account. In addition, they provide security and handle the task of settlements and clearing.
4. Lending in a Margin Trade
Some provide margin trading services to their clients based on their profiles. This service acts as a loan for the client to make trades in large volumes, which can result in big returns.
5. Compliance and Regulatory oversights
They are required by law to act in line with government regulations and ensure that their client is not making any transaction that can be seen as illegal.
Note
They are responsible for complying with relevant laws and regulations and ensuring their operations are conducted ethically.
6. Research and Analysis
They have teams specializing in stock picking and identifying opportunities in the market for their clients. These can range from fundamental analysis to economic and market research.
7. Trade Settlement
They do the trade settlement on behalf of their clients. They ensure that security can be transferred to the buyer and payment is made to the seller under the terms of the trade.
8. Reporting and Recordkeeping
They maintain accurate records of client accounts, transactions, and other activities. They must regularly update the clients on their account holding, transaction history, and performance.
9. Customer Service
At last, they also provide customer service to their clients in case of any issues concerning their accounts.
10. Execute Trade
In most financial markets, a trade order must pass through a broker, and brokerage firms help in the execution of trades by acting as a middleman between their client and the broker of the other party in the trade.
They can execute any trade per the clients' order or sometimes do trade at their discretion if the client has given his/her consent, and the broker sees it will benefit the client.
Note
In most countries, a person must have a brokerage account to access the financial market. Without an account with a registered brokerage, one can find it hard to get any protection in case of fraud.
Brokerage FAQs
Different brokerages have different business models, but generally, all charge a fee for their services.
Full-service broker firms charge high fees but, in return, give some of the best services one can have in terms of investing and wealth management.
Discount and online brokerage firms have different models that give individuals a platform to do self-trade and charge little to no fees. Instead, they make money by charging for additional services or assistance.
Before choosing a brokerage, one must ask certain questions about their investment goals.
a) Fees
Will you be ok with the fees charged by a full-service brokerage firm in exchange for an expert handling your investment, or do you want a more hands-on approach and low fees of discount and online broker firm?
b) Investment option
Not all brokerages provide their clients with all the available investment instruments. Most online and discount brokerage only offers more mainstream options like stock and bonds. More complicated investments like swaps and options are mostly locked behind the additional charge.
c) User experience and customer services
Most important of all is the quality of customer service, as in case of any issues and trouble how helpful they are to solve your quarry.
With the advancement in automated trading and AI, a new type of broker is emerging, known as a robo-advisor. These are like online brokerage in that both are online platforms for trading, but the robo-advisor uses a set of instructions and makes trades for you.
For example, a robot advisor will ask their client their risk tolerance, investment objective, and investment period. Then, in line with the instructions, it will use different algorithms and market data to make investment decisions just like any professional broker would.
In online brokerage, you are provided with a platform to trade by yourself, and most of the time, no additional advice is given concerning your trades.
While in a robo-advisor, you are given program instructions on how to invest and for what objective. With these guidelines, AI will trade to satisfy the guidelines without major human interference.
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