Survival of the Fittest
Theresa W. Carey
Mar 12, 2001
Survivor describes not only a hit television show but what online investors and brokers have been through in the past year. As the Nasdaq has been sliced by more than half, the breakneck growth of online trading has gone into reverse. But nobody's been forced to eat rats. Indeed, the survivors have benefited from their harsh experience of the last 12 months.
Our sixth annual survey of online brokers finds continued incremental improvement in the four occupying the top tier, a marked bunching of many brokers just below the very best, and respectable performance even among most of the also-rans.
The competition clearly has gotten fiercer with the slump in online transactions -- from just under a million per day in the second quarter of last year, to 850,000 per day in the third quarter, with only a small recovery to a 900,000 daily average in the final three months of 2000, probably because of tax-loss selling -- according to a report by J.P. Morgan Securities.
New online accounts continued to grow last year, albeit at a more moderate 53% rate, to 19.3 million, down from 1999's heady 73% increase. But the average account was less active, with an average of 2.9 trades per quarter in the final three months of 2000, down from five per quarter a year earlier. And poorer as well; the average online account was down to $49,000 in the fourth quarter from $70,200 a year earlier.
In response, brokers are offering lures, such as free trades, airline miles or cash rebates, to attract new customers. More substantively, most have tried to improve their infrastructure as well as the Websites themselves. A continuing area that needs improvement, however, is portfolio analysis and tax accounting. Too many online brokers rely on offline means of analyzing a portfolio -- exporting the data to a personal finance program or spreadsheet -- and sometimes requiring customers to perform data-entry chores, rather than transferring the information directly, even though they have the numbers available.
But the brokers apparently have heard the hue and cry from Barron's readers who called for better customer support. Over the past year, we've asked readers to comment about their online brokerage experience and to answer specific questions to help guide us in our reviewing efforts. Our thanks to the hundreds of respondents who helped us hone our rating system.
We've rated 23 Web-based brokers, including the top 15 in terms of trading volume, plus another eight of interest to Barron's readers. We're well aware that there are about three times as many online brokers out there. But, according to J.P. Morgan's data, the top 10 accounted for 95% of assets and 90% of the trades online. (We'll also look at direct-access brokers at a later date.)
We assumed typical Barron's readers (if there are such persons) could avail themselves of benefits for high account-balance holders -- over $100,000 in assets -- and make three round-trip trades per month. We made significant changes to our rating system, evaluating the brokers' offerings and performance in six areas, assigning a point value of 0 (low) to 5 (high) in each category. We then weighted the results according to the presumed importance to investors, adding to two the measures, and halving another.
The best possible rating Barron's could bestow is Five Stars -- which we have yet to award. Four brokers did cop Survivor's equivalent of a $1 million prize -- a Four-Star Rating. They are CSFBdirect , the recently renamed DLJ Direct, which barely edged out last year's winner, National Discount Brokers; industry leader Charles Schwab , which has moved up in this year's standings; and lesser-known newcomer, J.P. Morgan Online.
Ten brokers, a Barron's record, earned an estimable 3 1/2 Stars: Wall Street Electronica, Scottrade, Morgan Stanley Dean Witter , TD Waterhouse , Merrill Lynch , E*Trade , Fidelity, Quick & Reilly, A.B. Watley's "Watley Trader" and Mr. Stock. Each has strengths that will appeal to knowledgeable investors, but also a drawback or two that drop it down a notch -- and those minuses may not matter to you. The rest of the field was more bunched together this year; even the bottom-ranked broker got 2 1/2 Stars. A year ago, most of the surveyed brokers got three stars or less, and one broker earned a lowly single star.
What would it take to get the so-far unobtainable Five Stars? For starters, clearly written reports updated in real-time, plus price improvement on limit orders. Many readers wrote in to object to payment for order flow, so our rating system this year penalizes brokers who accept such payments. Proprietary research, well-organized links to third-party research, and great customer service also would be musts.
We looked for a streamlined order entry process, minimizing (or eliminating) the number of verification screens by utilizing field-by-field checking during data entry, while maximizing the amount of data available at the time of the trade. A real-time quote, presented before the order is entered, is essential.
Drop-down list boxes, or links to trading screens from a positions report or a research window, eliminating the need to enter ticker symbols, are a major plus. For example, if you select "Sell," there should be a drop-down box with the ticker symbols of issues in your portfolio, as well as the number of shares currently held, to avoid data-entry errors and inadvertent short sales.
We'd like to see an easy-to-read verification screen that is more than an echo of the order entry screen; that spells out the name of the security being traded, and shows the total value of the trade, including commission charges.
Final requests: an instant link to the status of the order, or a pop-up confirmation screen, followed by real-time updating of the trader's portfolio, plus portfolio analysis reports, with links to news and research, as well as transaction history going back at least 90 days. Readers also have emphasized the importance of tracking the tax consequences of each trade.
We ranked the brokers in six key areas, awarding or subtracting points in numerous sub-categories:
Visit Barron's at www.barrons.com for the latest financial analysis and commentary, updated daily.
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