Discount brokerages may help small-time investors play with big boys

January 09, 1994|By Jeff Brown | Jeff Brown,Knight-Ridder News Service

For the common folk, investors who'd like to actively trade stocks every few days or weeks like the big boys, but who only have a few thousand dollars to play with, there have always been two sad rules of thumb:

* The commissions will eat you up.

* By the time you hear the news that affects your stock, you've been trampled by the pros.

But these rules aren't as hard and fast as they used to be. Deep discount brokerages are substantially reducing commissions, and the spread of personal computers gives the ordinary investor inexpensive access to information and analysis that used to be the province of only the big players.

Financial advisers still caution that the small investor is overmatched by the pros and better served by a buy-and-hold strategy than frequent trading. But today someone who wants to gamble with as little as a few thousand dollars can actually make money in the short term, something that was far more difficult 10 or 20 years ago.

Before May 1, 1975, when the traditional system was overturned by Congress, brokerage commissions were fixed and standardized throughout the industry. Since then, competition has forced commissions down and led to the formation of discounters. In 1983 discounters captured about 4.6 percent of commissions paid by individuals, according to the Securities Industry Association. By 1992 their market share was nearly 13 percent.

Before the 1975 reform, an individual investor might have paid a commission of 3.5 percent on purchasing stock, plus 3.5 percent on selling it (adjusted for inflation). A stock had to gain 7 percent in value just to pay the commissions.

Today, discount broker Charles Schwab (800-435-4000) charges about 1.8 percent on a $5,000 trade, meaning the stock would have to go up only 3.6 percent to cover commission costs.

ETrade (800-786-2575), an electronic trading system investors can use with a touch-tone phone or a computer and modem through America Online, charges only 0.7 percent for a $5,000 trade, so that you begin to profit after your stock increases only 1.4 percent in value.

A price change that small is within the normal daily fluctuation of many stocks, while a 7 percent price increase required to cover commission costs in the old days is fairly significant.

Many discount brokers advertise in the business pages of newspapers or specialty publications such as Barron's, available newsstands.

The trade-off is that the discount brokerage houses don't give you any advice on what to buy and sell; they pass along what they save by not having ranks of analysts and sales people.

But without a good broker, how do you decide what to buy?

There are hundreds of newsletters that make recommendations, but many of them cost hundreds of dollars a year.

Peter Lynch, the stock market guru who guided the highly successful mutual fund Fidelity Magellan, says in his best-selling book "One Up on Wall Street" that the best stocks are often right around the corner: the new chain store you've stumbled across, or the maker of the new product you think is terrific. Or you can scrounge newspapers and business magazines for companies that look interesting.

Once you select an investment candidate, you can use a home computer to find out more about the company from an on-line data service that can be accessed with a modem connected to a phone line. Prodigy, one of the largest such services, sells its software and a modem for about $40.

The Prodigy service (800-776-3449), which costs $14.95 a month, allows subscribers to keep a constant watch on stock prices. Subscribers can create lists of stocks and have their prices updated everytime the service is accessed. And the list can be programmed to flag a stock whenever the wire services carries a news story about it.

For no extra cost, Prodigy subscribers can set up online brokerage accounts that allow them to buy and sell stocks through their home computers. Commission charges fall between those of Charles Schwab and ETrade.

For an additional $14.95 a month, Prodigy offers a "Strategic Investor" service that allows subscribers to search for stocks and mutualfunds by selecting from a list of criteria, such as earnings growth or industry. Then you can zoom in on a specific stock and get its corporate financial history.

CompuServe (800-848-8199) charges $8.95 a month for unlimited use of its basic service, which includes stock quotes. For additional fees, subscribers can get many of the information services used by the pros, such as analysts' corporate earnings estimates or company filings with the Securities and Exchange Commission.

America Online (800-827-6364), charges $9.95 a month for service that includes stock quotes, business news, trading and a portfolio tracking service that automatically updates when you buy and sell stocks.

The nonprofit American Association of Individual Investors publishes a 587-page directory of online services and analytical software, "The Individual Investor's Guide to Computerized Investing." It's available in the business sections of some bookstores or through AAII in Chicago (312-280-0170).

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