Shun Yan Cheung can remember a time when he would have had to pay a broker’s hefty fees to invest in the stock market. That’s why he invested mainly in no-load mutual funds.
But for the last two years, this mathematics professor at Atlanta’s Emory University has, along with millions of other Americans, invested on Wall Street from the comfort of his home computer, paying transaction fees that average five dollars per trade, and avoiding brokers like the plague.
Using a broker is not even a consideration. Internet brokerages like E-Trade have made trading convenient for Cheung. Would having a traditional broker be of any use to him? ‘If you mean a live one, no,’ he says. ‘The communication path to a computer is readily available; the human is not. Why waste valuable time if I can finish the trade in the time I would spend on hold?’
Cheung is confident that he can choose the winners himself – beating the Dow’s 11 percent return ‘hands down’ last year – and says he doesn’t miss the assistance of a real, live broker. ‘Nope. I think you’re the one that can best look after your own interests.’ As far as he’s concerned, the broker is a dinosaur well on the way to extinction, and judging from the hype surrounding the internet trading boom, a lot of people tend to agree.
There are already some 7 mn Americans trading online representing 25 percent of all US stock trades. Driven by deep discount transaction fees, the convenience of trading from home, and the profits to be made in a superheated bull market, that number is expected to grow exponentially over the next year.
Mistake makers
However, all that growth means there are a lot of inexperienced investors out in cyberspace, says Nancy Smith, director of education at the SEC. Left to their own devices, many of them are making a lot of mistakes – the SEC received 2,508 complaints in the first seven months of financial year 1999, ten times the number received in all of 1998.
Despite the current confidence of retail internet investors like Cheung, Smith says there is mounting evidence that many – even most – are not going to be able to do it all by themselves all of the time. That is likely to become more of an issue as and when the horrors of a bear market hits their investments.
‘What’s happening is that a lot of the competition right now is on transaction costs,’ Smith says. ‘But we’re seeing people start to ask what’s the value of a broker? and what’s the value of good advice? Some people will need advice, and they’ll be willing to pay for it.’
Even online brokerages have begun to tacitly concede that their customers may need a little bit of extra help over and above discounted dealing. As the stakes rise and the competition for customers heats up, it’s no longer enough for an online brokerage to merely provide a virtual cash register for do-it-yourself traders, says Susan Wolfrom, E-Trade’s director of investor relations.
Providing a positive – and profitable – trading experience is the key to keeping customers you have and attracting new ones, and that means providing many of the information-related services traditionally offered by brokers. ‘We’re focused not only on making investing more convenient, but on making you a better investor,’ Wolfrom says. ‘We’re trying to provide our customers with immediately actionable information, and we’re starting to move in the direction of becoming a digital financial media provider.’
Heavyweight research
E-Trade’s approach is far from unusual in the online world. Other online brokerages, notably Charles Schwab, spent much of the first half of this year adding investment information content and additional services to their internet offerings, while traditional full-service heavyweights like JP Morgan have reduced their asset requirements. The internet trading revolution appears to be going both ways.
‘There’s certainly still room in the mix for the full-service brokerage model,’ Wolfrom says. ‘The old model was the disintermediation of information. Information went from the analyst, to the broker to the consumer. We want to provide the same kind of information on a new, direct-to-the-consumer model.’
Moreover, Michael Grisham, a partner at the Burnett Group, a New York-based new media marketing and communications consulting firm, notes that the internet market serves a different kind of investor than the traditional brokerage house. And while the internet trading boom is influencing the way old-model brokerages do business, it doesn’t necessarily follow that it will completely subvert them.
‘These are really different people than the investors of ten, or even just five years ago,’ Grisham says. ‘It’s a whole different marketplace. It’s far more volatile and its size is really dependent on the current health of the stock market.’
That volatility could spell danger for the internet do-it-yourselfers. Grisham believes that the growth of online retail trading has been fueled, in part, by the ever-expanding bull market. It’s an environment where a trader can make tidy profits based solely on the odds of market growth, and he says that many consumers are being lulled into a false sense of security. ‘It’s easy to have confidence in your own judgment in a situation like this,’ he says. ‘But that will change with the market. Remember, most of these people have never seen a bear.’
Be prepared
That’s one of the SEC’s main concerns, according to Smith. The good times cannot last forever, and when the markets do eventually turn down – as they inevitably must – a lot of consumers are going to find themselves getting burned. ‘Retail investors have to understand that the markets we’ve seen have been unusual,’ Smith says. ‘They should be prepared for a downturn and volume more in line with historical averages. The danger is that a lot of these people haven’t had practical experience with that kind of downturn.’
Full-service brokerages will be able to play that downturn to their advantage, Grisham says. As the markets stabilize, the demand for expert advice and investment guidance will rise, a demand online discount brokerages will not be able ignore.
‘I would be serving my discount clients as best I can,’ Grisham says. ‘But I would also be trying to maintain a serious relationship with my more serious clients. Once the online boom settles down, they’re the ones that I’m going to be most interested in.’
Those are the clients that many of the more established firms are most interested in acquiring – and retaining – as they take their first tentative steps into online retail trading. Charles Schwab began a television advertising campaign extolling the virtues of access to a live financial advisor in the wake of a 28 percent drop in daily trades last spring. And after resisting the online flood for such a long time, Merrill Lynch announced back in June that it would be introducing internet trading services – but with an emphasis on its traditional brokerage services.
At $29.95 per trade, Merrill Lynch’s online offer can barely qualify as a discount service by the standards that are currently being set by brokerages like E-Trade. But that’s not the point, says spokesperson Susan Thompson. ‘The idea is to create a client migration path,’ she says. ‘In the long term, we expect our core relationship, full-service account to be our most compelling product.’
Killing costs
For those brokers who have been watching the steady growth of the online investment market with growing alarm, Merrill Lynch’s product offerings and the up-market moves by E-Trade and eSchwab toward more complete services are welcome evidence that they’re not completely dead yet.
Not dead, perhaps, but Jeremy Siegel of the Wharton Business School at the University of Pennsylvania believes they are in for some major changes. ‘The internet trading phenomenon has pretty much killed the per-transaction commission,’ he says. Siegel reckons that brokers should be seriously worried about their jobs if they are still charging commissions on transactions. The truth is that, with the emergence of fees based on assets, we have a far superior model, and brokers are going to have to re-invent themselves.’
Volpe Brown Whelan vice president Derek Brown observes that the one thing brokers have that retail investors seem to be willing to pay for is information. That alone may be the foundation of a new client-broker relationship. ‘There’s great value in one-to-one relationships,’ he says. ‘The question is how many brokers are going to be able to adapt to a new kind of relationship?’
In fact, it’s an evolutionary process that has been gathering steam for some time now, according to the SEC’s Nancy Smith. The traditional cold calls and monthly client updates were on the way out even before the influence of online trading became a factor. ‘The reality is that the financial services industry has been heading in that direction for some time,’ she says. ‘But it has been accelerated by the internet trading phenomenon.’
Merrill Lynch, though new to internet brokerage services, dispensed with the title ‘broker’ several years ago, preferring instead to refer to its investment experts as financial consultants. Changes in the pricing structure away from per-transaction commissions may even make these erstwhile-brokers’ services more attractive to retail investors.
‘It elevates the level of the financial consultant,’ Thompson maintains. ‘Because they get paid whether or not you trade, there’s no perceived conflict of interest. But there’s so much involved in a successful investment strategy – from tax planning to long-term trading – that we believe the services of a live consultant are always going to be needed. Let’s face it, you’re not going to work out a long-term strategy or provide complete complex financial services on a web site.’
