Getting profitable investment advice is essential to financial success, but it won’t do you much good if your stock broker is unable to execute the investment plan. So, it’s also critical to have a good stock broker. There are a lot of stock broker rankings out there, including Barron’s and SmartMoney, but they seem to rank a lot of features that I don’t find all that important. Rankings are only as good as the input values and formulas used to create them. If the inputs are not properly specified, the outputs won’t be worth a hill of beans (i.e., garbage in means garbage out).

Since I’ve been trading for 20 years and know a thing or two about brokers and trading, I’ve decided to list my top seven features of good stock brokers. If stock broker rankings were based only on these seven criteria, I would place more credence in them than I currently do. Disclaimer: even though I will name brokers that rate well for each criterion, I am not recommending that you use any particular broker. Here we go:

1. Commission and Margin Rates

The goal of investing is to make money. Profit equals revenues minus costs. If costs are too high, profits will be too low. Consequently, minimizing your costs of trading is a critical component of a successful financial plan. For this reason, right away I am discarding all full-service brokers — e.g., Merrill Lynch (a division of Bank of America (NYSE: BAC)), Morgan Stanley Smith Barney (a joint venture of Morgan Stanley (NYSE: MS)) and Citigroup (NYSE: C)), UBS AG (NYSE: UBS), and Wells Fargo (NYSE: WFC). They routinely charge well over a $100 per trade (1% to 2% of trade size) compared to less than a $10 flat fee per trade at most discount brokers. Sure, if you’re a hedge fund that needs block trading services or a multi-millionaire with estate planning issues, full-service may be the way to go. But for the average Joe like me, “full service” simply means full siphoning of my profits into their pockets.

Trading costs are not limited to per-share or per-option contract rates. They also include margin interest rates for those times you are so sure of yourself that you want to borrow money to leverage the trade.

Lowest-cost brokers:

Broker	Stock	Option	Futures	Margin Rate
Lightspeed	$0.0045 per share	$0.60 per contract	$0.60 per contract	6.00%
Interactive Brokers (NasdaqGS: IBKR)	$0.005 per share	$0.70 per contract	$0.85 per contract	1.59%

Investing Daily’s Roger Conrad and Elliott Gue, co-advisors of the MLP Profits investment service, offer a Broker’s Guide of “well-proven” brokers that continue to generate accolades from their subscribers year-in and year-out. In particular, they speak favorably of Interactive Brokers: “If you’re an independent investor who’s comfortable making your own decisions, Interactive Brokers is definitely worth a look.”

2. Free ETF and Mutual Fund Trading

Fidelity and Charles Schwab (NYSE: SCHW) can’t compete with Lightspeed and Interactive Brokers on general trading costs, but they have the cheapest rates (i.e., zero) for a select number of broad-based ETFs. A profitable business model based on free is a difficult one to pull off, but I’m guessing these brokers see free ETF trading as a loss leader to bring assets in the door which may generate trading commissions or management fees down the road. Furthermore, people who buy ETFs typically are buy-and-hold investors who don’t trade often, so the brokers aren’t losing much revenue.

In the case of Schwab (another broker that makes the MLP Profits short list), it offers free commissions only on 13 of its own Schwab ETFs so it will immediately generate asset management fees from their program. Fidelity offers free trading on 30 third-party ETFs, which is a lot more so I’m calling Fidelity the winner.

With regards to open-end mutual funds, both Fidelity and Schwab have a limited number (about 2,000) of “no-transaction fee” (NTF) funds that don’t require a commission if held long-term. However, Schwab charges a short-term trading fee if you sell a NTF within 90 days of purchase and Fidelity charges a fee if you sell within 180 days of purchase.

The clear winner in open-end mutual fund trading, however, is thinkorswim — unit of TD Ameritrade (NasdaqGS: AMTD) – which offers three free mutual fund trades per month on all of its 13,000 available funds and does not charge a fee regardless of how long (or short) you hold the fund.

3. Trading Tools

For traders, the Holy Grail is back testing. Fidelity’s Wealth-Lab Pro 5 and TradeStation Group’s (NasdaqGS: TRAD) Test Before You Trade are the best. For example, let’s say that you have a simple trading system based on buying stocks when they cross above their 50-day moving average (MA) and selling them when they trade under their 50-day MA or when they lose 8% of their value based on a trailing stop. Rather than risk real money on this unproven system, you can use the Fidelity and TradeStation programs to see how the system performed in the past.

Of course, historical testing only tells you whether something worked in the past; there is no guarantee that it will continue to work in the future. But a strategy that worked in the past is more likely to work in the future than a randomly-chosen trading strategy.

Fidelity’s Bond Ladder tool is good for fixed-income investing. As I wrote in part 4 of my asset allocation series, bond ladders allow you to obtain higher yields now while giving you the opportunity to reinvest cash when interest rates rise. Fidelity’s Portfolio Review tool, which provides basic asset allocation advice, is also useful.

4. Options

On Investing Daily and in my Options for Income premium investing service, I have written several articles on the various ways stock options can be used to enhance the returns of a stock portfolio. Whether it be selling covered calls to create dividends, selling puts to buy additional stock at a discount, or buying long-term calls as a low-cost stock replacement strategy, options have a place in virtually everyone’s investment portfolio.

Hands down, the options winner is thinkorswim. I may be biased because I have been a long-time thinkorswim brokerage client, but that doesn’t mean I’m wrong. Whereas most brokers require you to punch in the option symbol you want to trade, thinkorswim has a streaming option quote page where you can simply point and click your mouse to set up an options trade. And a drop-down menu lets you choose a complex multi-legged trade (e.g., a four-legged “iron condor”) without having to enter each of the legs. Free real-time futures quotes, scanning tools, analytics, and portfolio margining completes the picture. Very nice.

5. Foreign Stocks

With more than half of the world’s equity market capitalization outside of the U.S., one can’t truly have a diversified portfolio without investing in foreign stocks. Many excellent foreign companies don’t list on a U.S. exchange, and some actually delisted after the U.S. Congress passed the Sarbanes-Oxley legislation in 2002, which made U.S. filing requirements more burdensome and increased the criminal liability of company executives.

Investing Daily’s Peter Staas, managing editor of the flagship Personal Finance investment service, wrote an article last fall discussing foreign stock trading in which he stated:

Investing in international stocks diversifies your portfolio and limits its exposure to a single economy. But just as watching a travel show on TV isn’t as rewarding as actually visiting a foreign land, investing in foreign stocks that trade on the US over-the-counter (OTC) market is vastly inferior to buying these securities on the local exchange. Direct investment avoids the headaches that invariably arise from a lack of liquidity in OTC markets (especially when you want to sell a position).

Although Staas mentions a number of brokers that offer direct access to foreign exchanges (e.g., E*Trade (NasdaqGS: ETFC), EverTrade, EuroPacific Capital), his favorite is Interactive Brokers (that name keeps coming up!):

Hands down, Interactive Brokers remains the best way for investors to purchase foreign stocks directly; the firm boasts the lowest fees and access to an ever-increasing list of markets that even includes South Korea and other markets. All told, Interactive’s customers can order directly from over 70 exchanges worldwide.

That being said, this service doesn’t offer the research and handholding that many novice investors have come to expect.

Interactive Brokers is also one of only two brokers named on the website of Yiannis Mostrous’ Global Investment Strategist, the investment service focused on the most profitable emerging market stocks. If anyone should know the best stock broker for directly investing in emerging stock markets, it’s definitely Yiannis.

6. Dividend Reinvestment

As I wrote in The Best Stocks are Dividend Stocks, academic studies have clearly demonstrated that the key to true wealth in stock investing involves purchasing dividend-paying stocks and reinvesting the dividends. The problem is that keeping track of dividends and reinvesting those dividends back into the stock in a timely manner can be difficult, especially when the dividends are not sufficient to buy a round number of shares.

Consequently, I want a broker that will automatically reinvest my dividends for me, including purchasing fractional shares. The following website lists some brokers that do this: Bank of America, E*Trade, Fidelity, Firstrade, Schwab, TD Ameritrade, TradeKing, Vanguard and WellsTrade.

7. Investment Research and Banking Services

For investment research, you gotta go with Schwab. Not only does it have its own equity ratings, but it also provides clients with a recommended list of mutual funds and “turnkey” mutual fund portfolios for those without the time to manage their own investments. Schwab also offers independent research from Ned Davis Research, Standard & Poor’s, and Argus.

Brokerage banking services include check writing, online bill payment, direct deposit, and debit cards. Who needs a regular bank checking account anymore? Schwab, Fidelity and E*Trade all fit the bill here.

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