What it means
Traditional full-service brokers charge higher fees because they provide an adviser, investment research and often wealth planning. A discount broker strips away those extras and concentrates on executing trades quickly and cheaply.
The result is a lower cost per transaction in exchange for doing your own thinking. Many discount brokers charge a flat fee per trade, and some charge nothing at all for certain trades while earning money in other ways.
Those can include interest on uninvested cash, fees on funds, lending out clients' shares and payments from firms that execute the orders. A smart client looks at the full picture of what the broker earns, not only the headline commission.
Discount brokers became popular as trading moved online and as investors gained access to free price data and tools. Today they range from basic platforms with minimal services to rich ones offering charts, educational material and access to many markets.
Some also offer limited advice through automated tools. For businesses and individuals, the choice of broker is a cost-control decision.
A company treasury that holds a small portfolio, or an entrepreneur investing personal savings, can often cut annual trading costs sharply by using a discount broker. The saving matters most for people who trade often or invest regularly in small amounts.
The nuance is that cheaper is not always better value. A client who needs help with tax planning, retirement income or an inheritance may find that the guidance of a full-service adviser is worth the fee.
It is also worth confirming that the broker is regulated and that client assets are protected under local investor protection rules. Technology has shaped the model.
Mobile apps, fractional shares and automatic investment plans let clients start with very small sums, and many brokers now offer tax reports and dividend tracking at no extra charge. Finance teams advising staff on share plans often point to a discount broker as the simplest place to hold and sell shares.
In practice
Real-world examples.
Example
A software engineer invests $500 every month into a handful of index funds. She uses a discount broker with a flat $4 fee per purchase and no minimum balance. Her trading costs are under 1% of each contribution.
Example
A small business owner wants to move excess cash into short-term government securities. He opens an account with a discount broker and buys them himself online. He avoids the advisory fee his bank had quoted.
Example
A retired teacher with a modest portfolio finds she is paying $9,000 a year to a full-service firm. She moves part of her holdings to a discount broker and keeps a limited advisory relationship for tax planning. Her total costs fall by more than half.
Formula
Calculation
Annual trading cost = number of trades per year x cost per trade
An investor makes 40 trades a year. A full-service broker charges $60 per trade, so the annual cost is 40 x $60 = $2,400. A discount broker charges $5 per trade, so the annual cost is 40 x $5 = $200. The saving is $2,400 - $200 = $2,200 a year. Over 10 years, ignoring any investment growth on the savings, that is $22,000.Case study
Seen in the real world.
Oakridge Family Office is an illustrative, fictional firm managing $15,000,000 for three related households. It placed about 600 trades a year through a full-service broker at an average cost of $45 per trade, or $27,000 a year.
The new operations manager obtained quotes from three discount brokers and found one that would charge $6 per trade for the firm's volume, or $3,600 a year, with an additional platform fee of $2,400. The total came to $6,000, a saving of $21,000.
The managers worried about losing research, but they found that the households already relied on their own analysts. The illustrative lesson is that a firm paying for services it does not use is paying twice, once in fees and once in complexity.
Watch out
Common mistakes.
- Choosing a broker solely on the advertised commission, when other charges such as account fees, spreads and currency conversion can be larger.
- Assuming a discount broker gives advice, when most only execute the client's own instructions.
- Forgetting to check regulation and investor protection, which matter more than a few dollars in commission.
Questions
People also ask.
How do discount brokers make money if trades are cheap or free?
They earn from interest on cash balances, fund fees, margin lending, share lending and payments for routing orders.
Is a discount broker suitable for beginners?
It can be, if the investor is comfortable making their own decisions and uses the educational tools available, but beginners who want guidance may prefer an adviser.
What is the difference between a discount broker and a robo-adviser?
A discount broker executes your chosen trades, while a robo-adviser selects and manages a portfolio for you using an algorithm.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related