Study finds explosive growth for discount brokerages

After years of flat growth, do-it-yourself investing is once again on the rise. A growing number of Canadians — ill-served by market conditions — think they can do it better themselves and are signing up for discount brokerage accounts, according to J.D. Power and Associates.

The company’s 2009 Canadian Discount Brokerage Investor Satisfaction Study finds that nearly one-third of discount brokerage customers in Canada indicate they have been with their primary firm less than 12 months.

“The large percentage of investors who have migrated to these discount brokerage firms in such a short period of time is truly a true demonstration of the growth within this channel,” says Lubo Li, senior director and financial services practice leader at J.D. Power and Associates in Toronto.

Li suspects Canadian discount brokerage use is probably on a pace to catch up with the U.S. penetration in the market, which represents roughly 23% of the U.S. retail investors. Canada’s DIY crowd represents about 13% to 16%.

Li says what surprised his group about the study is that the demographic makeup of new discount brokerage users is very similar to that of people who comprise the majority of advisor clients. Very few of discount brokerage users execute more than one trade a month.

“Previously, the popular belief was that the discount brokerage was for serious day traders and online enthusiasts. If you look at the numbers based on our research it doesn’t seem to be that way. Only a handful of active traders are using discount brokerages, they only represent about 5 to 10%,” Li says. “The bulk of discount brokerage users are very similar to the average investor in terms of age, household income and even their investment attitude. In general, they are only slightly more aggressive than the average investor, and they are primarily investing for the long term.”

Dissatisfaction with the full-service advice seems to be one factor to the increase in discount brokerage usage. The J.D. Power study also notes that lower-cost exchange-traded funds (ETFs) — which can only be sold by IIROC-licensed advisors — and the introduction of the tax-free savings account (TFSA) seem to have attracted more investors to the DIY sphere.

Overall, discount brokerage investors hold more TFSAs (47%) and ETFs (16%) with all firms, including their primary brokerage, than do full-service investors (40% TFSAs and 11% ETFs). New discount brokerage investors have an even higher proportion of ETFs and TFSAs than those who have been with their primary firm for a longer period of time.

“One third of the online or discount brokerage investors have opened up their accounts within the past year. I think this sends a message to both the discount brokerage and full service brokerage channels,” Li says. “The message it sends to the full service channel is you can’t be complacent. You have to articulate the value of your channel and the value of your services you offer investors.”

Li suggests the higher uptake in discount brokerages could force more full service brokers and advisors to differentiate more clearly the value of the advice they offer.

Is there any opportunity to differentiate the transaction from the advice? Is there a way to monetize the value of advice you offer rather than bundle the transaction with the advice?” he says. “That is both a business question as well as regulatory question that is also a unique Canadian question.”

Indeed, the study would suggest there is an opportunity for clients to have a pot of discount brokerage money alongside assets overseen by a full-service advisor. Eighty-four per cent of discount brokerage account holders also use a full service advisor, private banking, financial planning or other bank-based wealth management services. In other words, only 15% of investors with discount brokerage accounts are truly DIYers.

Li suspects many of these investors are merely dabbling in managing their own money.

“These customers are finicky, they are shopping around, they are experimenting and they are dabbling. If they fail, they are going to vent their frustration on the discount brokerage channel. If discount brokers don’t offer a level of services they expect, they are going to leave very soon,” he says.

Scott Plaskett, a CFP and president of Toronto-based IRONSHIELD Financial Planning, says investors should realize that a discount on fees will not replace the value of time and experience a good financial planner provides.

“If an investor is moving down the DIY path to save fees, they need to be aware that their time is worth something also. Just because the upfront cost of investing can be lower than say investing in mutual funds, doesn’t mean that it is cheaper. It can take a tremendous amount of time to do proper due diligence on an investment. I would suggest that most DIY investors do not have a true working knowledge of a lot of the investments they are making,” Plaskett says.

A veteran advisor has years of training, which includes lessons and mistakes, and clients are probably not prepared to learn first hand, he adds.

“Take, for example, the basic rule of diversification. Sounds pretty simple — don’t put all of your eggs in one basket. But does a DIY investor really know what this means?” Plaskett asks. “Diversification goes way beyond not buying only bank stocks, it looks at diversification on many levels such as your diversification of your human capital versus your financial capital. If the company goes bankrupt, not only do you lose your job, you lose your future. Employees at Enron and Nortel would be a lot better off today if they were aware of this level of diversification.”

And many clients still do not fully understand that most full service advisors are more than investment advisor. Investments are a lucrative revenue generator, but much of the value they bring to clients is in tax and insurance planning, something a discount brokerage can’t really provide.

“Investing is just one component of a well-rounded financial plan. Understanding where and how investing fits into your overall financial plan takes time and a complete working knowledge of comprehensive financial planning,” Plaskett says. “If an investor is moving down the DIY path because they don’t trust their advisor, then they would be well advised to put their time into finding a new advisor they can trust as opposed to thinking that they can do a better job themselves.”

(07/16/09)