Which Broker? You Don’t Need One

When people start investing outside their 401k or 403b plan for the first time, their very first question is often "Which broker?" The answer should be "You don’t need one."

Vanguard is a great choice for beginning investors (and seasoned investors!), but Vanguard is not a broker. It’s a mutual fund company. Vanguard has a brokerage subsidiary, but it is primarily a mutual fund company.

What’s the difference between a mutual fund company and a brokerage firm then?

People sometimes use "broker" when they refer to either a company or a person, depending on the context. I use "brokerage firm" when I refer to the company, and "broker" when I refer to an individual person who works at a brokerage firm. The official term for the company is broker-dealer. The official term for the broker-dealer’s employee who takes customer’s orders is registered representative, or "registered rep" in short.

When you open an account with a brokerage firm, you can buy stocks, bonds, mutual funds, and ETFs. The brokerage firm is your intermediary. It holds those investment on your behalf. When you open an account with a mutual fund company, you can only buy mutual funds, and only mutual funds from that same company. You are a shareholder of the mutual funds you buy.

Every mutual fund is a separate legal entity, just like GE and GM are separate companies. Although mutual funds in the same "family" share some of the same vendors (investment advisor, distributor, and transfer agent), the funds are officially independent of each other.

When you buy mutual funds directly from the mutual fund company, you actually have an account with each and every fund you buy. This is different from a brokerage account, where you hold all the assets in one account. That’s why account statements from a mutual fund company always list the activities in each fund separately whereas statements from a brokerage firm interlace activities from different assets by date.

It becomes confusing when some mutual fund companies have a brokerage subsidiary while some brokerage firms have their own mutual funds. Still, companies are either primarily a mutual fund company or primarily a brokerage firm. Fidelity comes close to being equally strong in both. I list some of the popular companies and their primary roles here:

Company Primary Role
Fidelity Brokerage firm. Has in-house mutual funds.
Charles Schwab Brokerage firm. Has in-house mutual funds.
E*Trade Brokerage firm
TD Ameritrade Brokerage firm
Vanguard Mutual fund company. Has brokerage subsidiary.
T. Rowe Price Mutual fund company. Has brokerage subsidiary.
American Funds Mutual fund company
TIAA-CREF Insurance company. Has mutual funds and brokerage subsidiary.

When a mutual fund company has a brokerage subsidiary, the accounts are distinct. You need a separate brokerage account for stocks, bonds, ETFs, and mutual funds from other fund families. When a brokerage firm has its own funds, the in-house funds are usually held in the same brokerage account together with your other assets.

Although the first question is often "Which broker?" in most cases people who just start investing don’t need a brokerage account. A mutual fund company like Vanguard will serve them well.

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Comments

  1. says

    I have an account with ING Direct’s Sharebuilder online brokerage service. It doesn’t have the cheapest commission fees by far, but it dovetails with my online savings account nicely, and the free dividend reinvestment + $4 regular investment plan is kind of nice.

    I’d like to invest in some of Vanguard’s index funds, but the minimum capital investment is a little more than I’d like to put up at one time right now. I suppose I can just invest smaller increments in the ETF’s for those same funds, through Sharebuilder and such.

  2. says

    I’m a dull-time college student looking to make some strong long-term investments. I don’t know much about stocks, bonds, index funds etc. I’ve been looking into opening a Mutual Fund and/or IRA with Vanguard based on some basic research that I’ve conducted. I’m glad to see that I’m looking at the right company. This article has been most enlightening. Thank you.

  3. says

    Good stuff. The terms in the investment industry are murky and confusing and the investing public needs to understand the nuances.

    I agree that investors don’t need a broker, because the brokerage industry is built on a product-distribution model, not a client-service model. I am also a big fan of Vanguard as you are.

    I do think that many investors will benefit from working with a fee-only, indepdent advisor (which, since I am one, admittedly doesn’t make me impartial), because I believe that investment success if predominately about controlling your emotions. Sooner or later most people blink and succumb to the day’s conventional wisdom, whether it is overloading in tech stocks in late 1999 or bailing out of the market in early 2009. It only takes a couple of deviations like that to destroy a lifetime of financial discipline.

    For the steely minority who never, ever let short-term market conditions alter their long-term investment strategy — then Vanguard is definitely the right place to be.

  4. TigerTime says

    TFB – I agree that when people start investing outside their 401k or 403b plan for the first time, their very first question should NOT be “Which broker?” However, I don’t think Vanguard, Fidelity, or any other major Mutual Fund company is the solution since they don’t address the fundamental issue. The first question should actually be a series of questions aimed at identifying the investor’s objectives and risk tolerances. IMO Mutual Fund companies don’t provide an OBJECTIVE and complete evaluation for the majority of investors, especially those investing for the first time outside of a company plan. I do believe that SOME advisors and brokers provide valuable services to their clients, especially new clients who are still in the early stages of retirement planning. In full disclosure, I’m not an advisor or broker, but I have worked for both strictly in analytical roles. Investing directly with Mutual Fund companies should be a function of investor education. For highly informed and educated investors, such as yourself and many others who have spent hundreds of hours researching investments and have the self-discipline to stay on path, direct Mutual Fund investing is a logical choice. Others should strongly consider researching brokers and advisors who are willing to put their clients interests first with scrutiny and diligence (Not just blindly accepting a referral from your best friend). After all, if you’re willing to entrust someone with helping you meet your retirement needs for years in the future, you should be willing to spend at least several hours researching them thoroughly. Below is a link from the SEC on how investors can research brokers and advisors:

    http://www.sec.gov/investor/brokers.htm

    Jack – The SEC provides an overview of Mutual Fund investing along with a glossary of key terms. However, it’s not easy to find if you don’t have the link!

    http://www.sec.gov/investor/pubs/inwsmf.htm

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