SmartMoney magazine has released the results of their Annual Broker Survey in its June 2012 issue. Check out the attached article for additional commentary and insight into rankings and methodology. You’ll find my own commentary on their findings below.

SmartMoney 2012 Top 10 Overall

1. Fidelity
2. Scottrade
3. TD Ameritrade
4. E-Trade
5. Schwab
6. TradeKing
7. Zecco
8. Merrill Edge
9. Capital One 360 Sharebuilder
10. WellsTrade

Best in Commission & Fees Category (5 stars)

Scottrade doesn’t have a rock-bottem per-trade commission at $7 a trade, but it’s lower than average and they still win overall due to lower fees elsewhere – such as annual fees, inactivity fees, fees to use a phone, or close out an account.

1. Scottrade
2. Capital One 360 Sharebuilder

Best in Customer Service Category (4 stars+)

One important factor here was speed of reply in addition to accuracy, and per the article all of the brokers surveyed now offer Live Chat online except for WellsTrade. I think TradeKing was the first to offer this feature?

1. TradeKing ($50 opening bonus link)
2. Scottrade
3. E-Trade
4. Zecco

Trends

• Prices are still dropping, although more slowly. SmartMoney reports that in 1994 the average commission price surveyed was $28. Last year, $8.27. This year, only $7.96. Note that every single one of their top 10 brokers have per-trade stock commissions of under $10. I suppose anything higher would just seem greedy now.
• Banking. More firms are adding banking features like debit cards and billpay to make it more likely that you’ll keep all your money there, joining firms like Merrill Lynch (Bank of America) and WellsTrade (Wells Fargo) which are already closely aligned and owned by big banks.
• Smartphone and iPad apps. These are indeed cool, but the brokers really love them because they increase your trade activity.

Omissions

SmartMoney mentions the the Merrill Edge BofA deal, where you can get 30 free trades a month if you hold a combined $25,000 as cash in your *deposit* accounts only at Bank of America. However, they don’t mention the WellsTrade deal which offers 100 free trades a year if you hold a combined $25k across acounts including your brokerage balance, but instead requires a PMA checking account that you have to keep active with “in-person” activity like writing a physical check at least once a year.

WellsTrade and Zecco enter the top 10 this year, but Vanguard and OptionsXpress were bumped out. Vanguard was #7 in their 2011 rankings. There was no mention of what happened… I’d like to know if they were notably worse in some area or were simply excluded? OptionsXpress was bought by Schwab last year, but still runs an independent site.

Finally, there was no mention of the quantity and quality of the commission-free ETF lists offered by the majority of these brokers. If anything, I thought that was more important to mention than smartphone apps that scan product barcodes at the grocery store.

Finding The Best Broker For You

Don’t forget to compare these results with the Consumer Reports 2012 Rankings and the Barron’s 2012 Rankings. The key is to drill down to see which broker satisfies your personal set of needs the best, as there is a lot of fluff in there. This is why I’d rather look at specific sub-rankings more closely than the big headline “Top 10” rankings.

Take the “Banking” category, which included as a criteria but some brokers just don’t offer banking services and I don’t think they should be penalized for it. Another area I don’t care about is “Research” tools. I’ve ever used a broker for research. Morningstar offers me everything that I need, otherwise I just look at Google/Yahoo quotes and look for related news and blog articles. I don’t see how a discount broker would have the time or resources for unique analysis. Just give me cheap trades with good fills, solid customer service when I need it, and track my capital gains and tax lots accurately.

I am often reminded when talking with friends and coworkers that most people don’t understand the important of low fees when it comes to investing. The Vanguard blog had a recent post exploring why a 1% expense ratio is much more significant than it appears. The problem is that expense ratios aren’t charged to you directly as a line item like an overdraft fee or a monthly bill – it is quietly taken away in tiny pieces from your returns which makes it easy to ignore.

For another, fees are expressed as a fraction of assets. A 1% equity management fee seems small and reasonable. “One percent” just sounds tiny – as in “there’s a 1% chance of rain tomorrow.” But suppose you reframe fees in other terms. Suppose you expect a stock fund to earn 8% over the long run. Assuming inflation of 3% and a tax rate of 25%, you’re in effect paying one out of every three dollars of future expected return in costs.* A fee of “one third of all of the money you make” sounds like a lot, especially when many money managers could do worse than the market averages.

Basically, if you are expecting to earn 3% a year above inflation after taxes, paying 1% to a manager is like paying 1/3rd of all your earnings. As you can see below, I could own the S&P 500 for as little as 0.05%. Things get even worse when looking at bond funds and their tiny yields.

Research has shown repeatedly that costs matter more than star ratings and past performance. The lower the expenses, the less headwind year in and year out.

With that knowledge, Vanguard has announced another round of fee cuts! Vanguard says the price drops are a result of them being client-owned and passing on any savings resulting from increased assets. Others speculate that it’s a reaction to competition from other low-cost ETF providers like Schwab. Either way, investors win. The drops are pretty small, but to me it’s like getting a little guaranteed boost in returns that will compound every year. A selected sample of funds with fee drops below:

Admiral shares are now open in most index funds with a $10,000 investment, and you can always start like I did with the Investor shares at $3,000 and convert to Admiral when the balances grow. ETFs usually offer the same low expense ratios as Admiral shares, but you should also keep in mind the cost of trade commissions. Buying Vanguard ETFs and mutual funds directly with an account with Vanguard is free. TD Ameritrade also offers commission-free trades on a wide variety of Vanguard ETFs (along with other providers).

Over the last year or so, Vanguard has made several moves that lowered my portfolio costs. They added Admiral shares, removed purchase fees on their Emerging Markets fund, and dropped expense ratios again.

Weekly business newspaper Barron’s recently released their 2012 annual broker survey rankings. A change from last year is that now the quality and availability of mobile apps for smartphones and iPads are now part of the criteria, as well as more attention paid to the ability to place transactions directly on international exchanges.

Barron’s admits their overall rankings are based on the needs of their paying subscribers – namely “wealthy, active traders”. As such, their overall winner was Interactive Brokers, which has an extensive feature set with low per-trade commissions but also requires a minimum opening balance of $10,000, a minium monthly fee of $10, and is lacking customer service especially for smaller investors.

I am not an active trader, I would say I do less than 50 trades a year mostly using ETFs. Based on no data whatsoever, I would guess that most readers here are also not active traders and don’t need a full-service terminal with real-time streaming charts and complex options order-entry capability. (Although I know some of you are.) Now, I still like having real-time quotes, a nice user interface, and friendly service when I need it. So thankfully Barron’s also ranked the brokers for other investing styles:

Top 5 Brokers for Novice Investors

1. TD Ameritrade. Notes above-average costs, but more features and good mobile app. Curiously, no mention of the 100 commission-free ETF list.
2. Fidelity
3. E-Trade
4. Charles Schwab
5. Capital One 360 Sharebuilder

Top 5 Brokers for Long-Term Investing

1. Fidelity – Notes good mix of reasonable cost, research tools, and overall usability.
2. TD Ameritrade
3. Charles Schwab
4. E-Trade
5. TradeKing

Top 5 Brokers for In-Person Service

1. Scottrade. Notes over 500 physical branches across US.
2. Merrill Edge
3. Charles Schwab
4. Fidelity
5. TD Ameritrade

I found it weird that they mention Scottrade’s meager list of proprietary commission-free ETFs that nobody hardly uses, but completely ignore the fact that TD Ameritrade includes 100 of the world’s largest and most heavily traded ETFs on their commission-free list. I guess they really are laser-focused on daytraders and people trading on Asian exchanges in the middle of the night.

There will always be debate regarding investing in actively-managed stock pickers vs. passive index followers. But even for active managers, costs matter more than star ratings and past performance. The lower the expenses, the less headwind year in and year out.

The best thing about using Vanguard funds is that they have consistently lowered my investment fees over time as their own costs have dropped. When that happens, it’s like getting guaranteed higher returns that continue to compound each year.

Last year, they lowered the fees on several funds and also added Admiral shares. Last month, they dropped some fees on their Emerging Markets fund. Most recently, they announced another round of expense ratio cuts. Check the article for all the funds, but here are the ones that I hold:

The total weighted expense ratio of my investments is probably under 0.20% annually now. The only way to go lower is to hold the stocks or bonds directly in a brokerage account, and even then I have consider commission charges.