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Online discount trading set for another boom

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The online discount brokerage business took off like a rocket during the stock market boom.

Advertisements and commercials for do-it-yourself stock buying were everywhere. One quirky young fellow with a Mohawk haircut was featured in a series of commercials happily urging seniors to give online trading a go. All the new online brokerage firms went on a hiring binge, adding armies of account people and banks of telephones.

Then, poof! The bear market extinguished it all. Few ads. No Mohawks. Staff and equipment cut to the bone. Stock investing was no longer a game, because it turned out those shares you selected so shrewdly could actually go down in value.

Now, with the stock market kicking up its heels once again, there is hope for a revival in the online discount trading business. While the trade-off of low-cost trading but no advice makes sense for many investors, wooing them back won't be easy.

"I still use ETrade to buy certificates of deposit, but I haven't traded stocks in a while," said Dan Brenner, 28, a student at the University of Chicago Graduate School of Business. "Last year, I sold all the stocks that I bought over the past several years basically because I lost money on all of them and wanted to take a tax write-off."

In 1998, Brenner opened his online discount brokerage account in part because it was a novelty but mostly because he received Delta Air Lines SkyMiles for his $1,000 deposit.

"I wanted an online broker so I could make all the decisions myself," recalls Brenner, who appreciated the broker's research and other services even though he didn't use them much. "I don't know, but if I get into stocks again, I might want more advice."

Investing on your own only makes sense if you have confidence in your own ability to use information effectively.

"Know yourself and what you can do and can't do," advised Dan Burke, vice president of research for the Gomez (www.gomez.com) research firm in Waltham, Mass. "Those who aren't truthful with themselves about their financial acumen can get into situations that result in a lot of pain."

Commissions for an online discount broker trade can range anywhere from $5 to $35, said Burke. There can also be fees of $10 to $25 a quarter for inactivity, as well as annual account fees of as much as $50. If you're not actively trading and your money's sitting in cash, those fees make a difference.

Brokers are now emphasizing a linkage between brokerage and banking services so investors will keep all their money with the same firm. They're working to lower operating costs by putting customer services, such as changing an address or looking at a statement, online for the investor to handle himself.

The industry is positioning for another boom.

"After a three-year bear market, we're in the early stages of long-term recovery for discount brokers," said Colin Clark, brokerage industry analyst with full-service broker Merrill Lynch in New York. "They all have very lean cost structures, so a pick-up in market activity means substantial earnings power across the group."

Though online discount brokers offer various "bells and whistles" to attract certain customers, they're primarily competing on the price of their trades, Clark said. For those investors considering the purchase of the stocks of brokerage companies themselves, he currently recommends shares of Ameritrade Holding Corp. (AMTD) and ETrade Group (ET).

"We've noticed a pattern among savvy individual investors of wanting a full-service broker first and then going to a discount broker once they feel confident about making their own decisions," said Ken Janke, president and chief executive officer of the National Association of Investors Corp. www.better-investing.org, which sponsors investment clubs around the world. "Down the line, depending on how confident they feel about computers, they do online investing."

The biggest loss in going with an online discount broker is receiving less research, said Janke. Though Wall Street research has been under fire for its biases, a lot of its work is quite accurate, he believes. He thinks investors shouldn't worry about analyst buy and sell recommendations on shares, however, and should instead use their information to help in investing for the long term.

Discount and full-service brokers will coexist because investors have their own individual needs. Furthermore, even within each category there are differences in quality and characteristics of the brokerage firms.

In terms of the lowest-cost stock trades as tracked by Gomez, the top online discount brokerages are: BrownCo, Scottrade, Firstrade, Netvest and Ameritrade.

Based on an overall score that takes into account ease of use, customer confidence, on-site resources, relationship services and overall cost, the top online discount brokers are: Fidelity Investments, Charles Schwab, ETrade, Harrisdirect, TD Waterhouse, Ameritrade, WellsTrade, Cititrade, American Express Brokerage and Scottrade.

Full-service brokers also have online sites. Gomez currently ranks them on their overall score as follows: Salomon Smith Barney, UBS Paine Webber, Merrill Lynch, Morgan Stanley, Prudential Financial, Wells Fargo Investments, DB Alex. Brown, Piper Jaffray, Legg Mason and McDonald Investments.

Andrew Leckey answers questions only through the column. Address questions to Andrew Leckey, "Successful Investing," P.M.B. 184, 369-B Third St., San Rafael, CA 94901-3581 or by e-mail at andrewinv@aol.com.