📚 Investor Guidebook: What Broker To Use & Types of Investors
Episode 2 of the Investor Guidebook
Hello friend! 👋
My name is Yorrin, also known as ‘‘Fluentinvalue’’.
Welcome back to episode 2 of the Investor Guidebook. A detailed series where I each week discuss relevant subjects to help you get set up.
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Choosing the right broker
Choosing the right broker is crucial to profitable investing.
Like every company out there, money needs to be made. Brokers make revenue via fees, transaction costs, currency, interest, and more. As investors, we want to keep as much money as possible to invest, not to fund our broker. Choosing the broker that best fits your needs can be a journey. You need to figure out what type of investor you are, if you will be actively trading, passively trading, and more.
So, let us chat about it for a bit!
Know your needs
Before you get all thrilled about signing up and start investing, stand still for a couple of minutes.
When you are just starting, there might be a need for customer support, educational tips & tricks, and paper trading. Look at criteria that you find crucial and need to be met before opening a brokerage account. Not all brokers offer guidance, customer support, or paper trading. Picking a good broker is, besides investing, the most crucial part.
Take the time to evaluate your priorities and understand what you need from a broker. Are you looking for a platform with comprehensive educational resources to help you learn the ropes? Some brokers offer extensive libraries of articles, videos, webinars, and even one-on-one coaching sessions. This can be incredibly beneficial if you're new to investing and need a solid foundation.
Customer support is another essential factor. Imagine encountering a problem with your account or a trade and not being able to get timely assistance. Look for brokers that provide robust customer service, including 24/7 availability, multiple contact methods, and knowledgeable representatives who can quickly resolve issues.
Paper trading, or simulated trading, is a valuable tool for beginners. It allows you to practice trading strategies without risking real money. Not all brokers offer this feature, so if it's important to you, ensure that it's available. This can give you the confidence to make real trades when you're ready.
Furthermore, consider the usability and functionality of the broker's trading platform. Is it user-friendly? Does it offer the tools and features you need, such as advanced charting options, real-time data, and customizable dashboards? A good platform should enhance your trading experience, not complicate it.
Fees and commissions are also critical. High fees can eat into your profits, so look for a broker with a transparent fee structure. Compare the costs of trades, account maintenance, and any other charges that might apply. Some brokers might offer commission-free trading but have higher fees elsewhere, so it's important to get the full picture.
Regulatory compliance and security are non-negotiable. Ensure that the broker is regulated by reputable financial authorities and that they have strong security measures in place to protect your personal and financial information. This includes encryption, two-factor authentication, and insurance policies in case of fraud or theft.
Lastly, read reviews and get feedback from other investors. Hearing about others' experiences can provide valuable insights into what you can expect. Join online forums, check out ratings on financial websites, and don't hesitate to ask questions.
In conclusion, choosing the right broker requires careful consideration and research. It's not just about finding a platform to execute trades; it's about finding a partner that supports your investing journey with the right tools, resources, and services. By taking the time to evaluate your options, you can make an informed decision that sets you up for success in the world of investing.
I know my needs and have a selection of brokers, now what?
I am happy you found the selection of brokers that fit your needs!
Now the part comes when you look at the costs that the broker has for using its platform, executing trades, switching currency, and other relevant fees. To determine what fits your needs, you need to know what type of investor you are going to be, let us discuss the types of investors and see where you belong to. Do keep in mind you might change what type of investor you will be later in life, so be thorough in picking and choosing a strategy. Changes are inevitable, trust me. So it is up to you to use critical thinking and make a solid investment plan with an outlook far into the future of your needs and wants.
Let us chat about the types of investors and get back to this question later on.
Types of investors
There are two types of investors. The passive investor and the active investor.
The passive investor
A passive investor is someone who employs a long-term, hands-off investment strategy that focuses on minimizing trading and management costs. This approach involves investing in a diversified portfolio that typically mirrors a market index, such as the S&P 500 or a global market index, and holding these investments over an extended period. The main characteristics and benefits of passive investing include:
Index funds and ETFs
Passive investors primarily invest in index funds or exchange-traded funds (ETFs) that track specific market indices.
These funds aim to replicate the performance of the chosen index by holding a similar proportion of the underlying assets.
Stock picking
Picks stocks and holds them for a longer period.
The stocks tend to be companies with a solid track record, robust income statement, balance sheet, and cashflow.
Long-Term Horizon
Passive investors usually have a long-term investment horizon, often spanning decades.
They aim to benefit from the overall growth of the market over time rather than seeking short-term gains.
Low Costs
Passive investing involves lower fees compared to active management because it requires less frequent trading and lower management expenses.
The reduced costs contribute to higher net returns over the long run.
Diversification
By investing in broad market indices, passive investors achieve a high level of diversification across various sectors and industries.
Diversification reduces the risk associated with individual stocks or sectors.
Minimal Trading
Passive investors engage in minimal trading, avoiding the attempt to time the market or pick individual stocks.
This approach reduces the impact of market volatility and trading costs.
Steady Performance
The performance of passive investments typically mirrors the overall market performance, which has historically trended upward over the long term.
While passive investments won't outperform the market, they also won't underperform significantly.
Benefits of Passive Investing
Simplicity
Passive investing is straightforward and less time-consuming compared to active investing.
Investors do not need to constantly monitor the market or make frequent investment decisions.
Predictable Returns
Since passive investments track market indices, their returns are more predictable and aligned with the broader market performance.
This predictability can be reassuring for investors seeking steady growth.
Reduced Stress
The hands-off approach of passive investing reduces the stress and emotional decisions associated with active trading.
Investors can remain focused on their long-term financial goals without reacting to short-term market fluctuations.
Historical Performance
Many studies have shown that passive investing often outperforms active investing over the long term due to lower costs and the difficulty of consistently beating the market.
The active investor
An active investor is someone who takes a hands-on approach to investing, actively buying and selling securities to outperform the broader market or a specific benchmark. This approach involves frequent trading, detailed analysis, and a more dynamic strategy compared to passive investing. Here are the key characteristics and benefits of active investing:
Characteristics of Active Investors
Frequent Trading
Active investors engage in frequent buying and selling of securities to take advantage of short-term price movements.
This can include stocks, bonds, options, and other financial instruments.
Market Timing
Active investors attempt to time the market, buying when they believe prices are low and selling when they believe prices are high.
This requires constant monitoring of market conditions and trends.
Active Management
Active investing often involves using actively managed mutual funds or hedge funds, where fund managers make decisions about how to allocate assets within the fund.
These managers use their expertise to try to achieve higher returns than the market average.
Higher Costs
Due to frequent trading and the need for professional management, active investing typically incurs higher fees and transaction costs compared to passive investing.
These costs can include management fees, trading commissions, and taxes on short-term capital gains.
Customized Strategies
Active investors can tailor their investment strategies to their specific goals, risk tolerance, and market outlook.
This flexibility allows them to adjust their portfolios in response to changing market conditions.
Benefits of Active Investing
Potential for Higher Returns
Active investors aim to outperform the market by identifying and capitalizing on investment opportunities.
Successful active investing can lead to higher returns compared to the market average.
Flexibility and Adaptability
Active investors can quickly adjust their portfolios in response to new information, market trends, or economic conditions.
This agility can help manage risk and take advantage of short-term opportunities.
Risk Management
Active investors can use various strategies to manage risk, such as diversifying their portfolio, using stop-loss orders, or hedging against potential losses.
They can also avoid or exit investments in declining sectors or companies.
Personalized Investment Goals
Active investing allows for more tailored strategies that align with individual goals, such as growth, income, or capital preservation.
Investors can focus on specific sectors, industries, or themes they believe will perform well.
Common Strategies for Active Investing
Momentum Investing: Buying securities that have shown strong recent performance and selling those that have underperformed, based on the idea that trends will continue.
Day Trading: Buying and selling securities within the same trading day to capitalize on short-term price movements.
Swing Trading: Holding positions for several days or weeks to profit from expected upward or downward market swings.
Risks of Active Investing
Higher Costs: Increased fees and transaction costs can erode profits.
Market Risk: Active investors are exposed to the volatility and unpredictability of the market.
Performance Risk: There is no guarantee that active management will outperform the market, and many actively managed funds fail to do so after fees.
Emotional Decision-Making: Active investing can be stressful, leading to decisions driven by emotions rather than rational analysis.
So, back to the question
‘‘I know my needs and have a selection of brokers, now what?’’
You have your selection and you know what type of investor you likely will be, you can start to make an informed decision.
If you are going to be an active investor, there will be higher fees. In this case, you would need to filter on lower fees. Also, active investors need fact execution of their trades, every second counts. Try to look for brokers with fast execution rates and low fees. Because you are active, you do not want fees to eat up your profits.
As a passive investor, the one who rarely makes trades, your selection of brokers is a little more broad. You rarely trade, so, fees are not a big issue. You can filter on lower fees, but it is not crucial. In your case, you can pick a broker that offers the needs like education, customer support, and more.
What to look out for in brokers?
There are some crucial points to look out for with your brokers.
Is the Brokerage a Member of the Securities Investor Protection Corporation (SIPC)?
You can look this up on the SIPC websiteIs the Brokerage a Member of the Financial Industry Regulatory Authority (FINRA)?
You can look up brokerages on FIRNA’s broker check websiteIs the Brokerage Covered by the Federal Deposit Insurance Corporation (FDIC)?
What Kind of Insurance Do They Provide to Protect You in Case the Company Fails?
Members of the SIPC should have the proper insurance with a per-customer limit of at least $500.000. The company should ideally provide additional coverage above and beyond the basic requirements of the SIPCIs There Any Kind of Guarantee of Protection Against Fraud?
You must try your best to avoid fraud on your side. But, companies should offer the right tools too to avoid fraud, do they?What Are Current Customers Saying?
This is very important! Customers online and on review sites will let you know if the broker you choose is trustworthy of your hard-earned money and if it follows all guidelines to ensure your account safety.Does the Brokerage Website Offer Two-Factor Authentication?
This is a must in my opinion. Brokers need to double down on ensuring your account will be safe from any threats.What Kind of Technology Does the Broker Use to Keep Your Account Safe?
Look into the company its disclosures to see if the company uses quality encryption that is needed to ensure your account safety.Does the Company Ever Sell Customer Information to Third-Parties (like Advertisers)?
This is always a big NOWhat Kinds of Accounts Does the Broker Offer Besides Standard (Taxable) Investment Accounts?
Do they offer ESA accounts (educational savings accounts) or custodial accounts for your child?Can You Open a Retirement Account?
See if the broker offers Roth or traditional retirement accounts and if you can roll over an existing one
Test, test, and test!
Believing words online and what the company says is fine, but verifying it is better.
Open a paper trading or dummy account and see what the platform has to offer and if it is like advertised or praised for by its customers.
You are going to deposit your hard-earned money, so make sure you do your due diligence before trusting someone or a company. If you do not do your research, I am sorry, but then you are a dummy! Would you lend someone a $1.000 who you have never met? No! So why would you trust a company that you have not thoroughly looked into before making a deposit. ;-)
Test the services, customer service, and everything that you can and want to test.
If it passes the test, you might just have found your broker!
Conclusion
Picking a stock is a tough task that needs to be done. Like I said earlier on, you do not trust a stranger with your money, why should you trust a business with your money if you know nothing about them?
Investing is not about being smart, it is all about critical thinking. With every step you take, take a breather and think about if it is the right call to make for you at that moment. When something seems too good to be true, it usually is!
Pick what type of investor you will be and carefully pick the broker that fits all your needs. Of course, there might be a small chance that every broker does not fit all criteria, sure. It is up to you to decide what matters most and what doesn't.
Tip from me: The safety of your money and account should always be the top priority! This is something you should never skip out on. Make sure the broker fits and obeys all regulations and laws that your government requires. Make sure they are part of the government institutions that monitor and track brokers.
This all might seem a little excessive, but I am sorry. But I would hate to hear that you have lost your money due to a fraudulent broker, that would shatter my heart.
And remember, always be critical. Critical thinking saves you from disasters!
I would say even to be critical of what I am saying here. ;-)
(P.S. I will not recommend any brokers. I want you to do your research and not to be influenced by me. If you have any questions about your broker, I am pleased to look into the broker with you. Just contact me over on Twitter/X)
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