This is my first post of any real length - disclaimer; it’s probably going to be a long one, but I hope it proves useful to at least some people.
I remember trawling through dozens of finance forums/discussion groups when I started out investing and was looking for a brokerage to use for the money that I had saved in the years after school and during university. Generally speaking I found these to be awash with inconsistent advice, sweeping or otherwise vastly incomplete answers to what are fundamentally quite complex questions, or sometimes just plain misleading. For example a new investor might create a thread and ask something like “I’ve been reading about stocks vs bonds in my portfolio, what’s a good ratio to use?”
Things to consider are not limited to, but should include:
Before thinking about diversification between stocks and bonds, how diversified are your stocks and bonds? The bonds are almost certainly bond ETFs, or Exchange Traded Funds and not actual bonds (a fair amount of hassle is involved in purchasing individual bonds as a retail investor), but assuming your stocks are in index funds/ETFs, which indexes around the world are you tracking, and why? Have you given any thought to this? Are you unintentionally overweight in some individual shares/sectors/indices/countries, if so, do you care about this? (If intentional this is a different matter - for example you might make the conscious decision to only track the S&P 500 index because of its historically higher growth vs other indices. You should be aware though, that if you do this your shares are concentrated in U.S. domiciled companies, even if their business is global. For example, Sony is a Japanese company with a $60B+ market cap that trades within the Nikkei 225 Index (among others) in Japan, so by not owning a piece of the index you are potentially missing out on any growth that Sony experiences, and the growth of other economies around the world. Again, there’s no right or wrong here, just something to consider.)
Interest rate risk: you should learn how the IR affects a bond’s yield and price, and the fact that your bond indexes don’t necessarily behave the same way as bonds, depending on how many bonds the index tracks. As a new investor you might invest, let’s say, 10% of your portfolio into a bond ETF, thinking “great, that amount is a sure plus two-to-five percent, I’m more diversified now” and get negative returns at the end of the year after an interest rate hike because you didn’t fully understand the risks.
*Japan is an excellent case study in what happens when the interest rate stays very, very low for a long period of time.
*Relating to the above, do the bond ETFs you’ve chosen protect against currency risk? (e.g. are they all UK government bonds trading in GBP or are they globally diversified? or perhaps all in a single foreign currency but hedged to yours?) If not, why? (If the bonds in the ETF contain a wide spread of currencies, you are protected somewhat: for example, if GBP depreciates vs USD, you’ll lose on the GBP side, but offset it with the gain on the USD side, as FX is a zero-sum.) Again, there’s nothing necessarily wrong with having all your bonds in 1 currency; (if you anticipate stable/falling interest rates in the country in question, for example), but you should be thinking about things like FX risk any time you buy a bond or bond ETF, without exceptions.
*The fact that bonds and stocks are NOT the only assets that you can easily include into your portfolio to reduce the volatility of owning shares, these include gold (either in physical form or in an ETF,) general commodities (again this would be more commonly bought through an ETF as a non-institutional investor like you and I, unless you’ve got a spare warehouse for your 50 barrels of crude oil) or even Treasury Bills/Cash. A portfolio doesn’t have to be all stocks if you don’t want it to be, and bonds aren’t the only option if you want to diversify!
(By the way, here is an absolutely fantastic visual resource for exploring how different allocations of asset classes (shares, cash, stocks, gold etc) can change the risk/reward relationship of your portfolio. I HIGHLY recommend you spend some time exploring it, particularly if you are new to investing.)
*And of course the ever important:
“When do you plan to retire, and will you be living exclusively off the investments you’re making now, or do you have others?”
“What time horizon are you thinking about when you look at your portfolio figures on the screen?”
“Regarding the above, are you sure? Is your risk tolerance that high? Could you keep investing cash into your portfolio and watch it sink further into the red week after week, month after month, year after year in a bear market without panicking, selling your positions and re-allocating to something else?” (There’s nothing wrong if the answer is “no” or “I’m not sure”, it’s just an indicator that the weight of equities in your portfolio might be too high for your risk tolerance.)
And so on and so forth; there’s a lot more to be said, but you get the point. The top reply to the question on these forums would be something like “60/40 is pretty standard. Start with that and then play around.” Personally I’d rather be pointed towards resources and/or asked questions; if my answer to those questions is “I have no idea” then I’ve got some research to do! These replies would descend all the way down to “put all your money in crypto and gold, don’t even bother, a crash is imminent.”
This is just the first example I could think of! After reading one too many comments like this on some of the larger forums, I stayed away for the most part and stuck to books and learning on the go.
I spent a considerable amount of time researching brokers when I first started looking to trade stocks, and after perhaps a few months I settled on the brokers that I felt best suited my situation. A few years later I ended up coming across a post along the lines of: “Brokers: What you pay for is what you get.” It reaffirmed a lot of what had gone through my head when doing my own research, and also put some things into perspective that I hadn’t considered. To that end, and not having the post to hand, I’ve made my own version and hopefully it helps at least one person make some more informed decisions and perhaps changes their attitude to due diligence in all things financial.
Note: This is simply a list of things I think are important to consider before picking a broker to invest your money with. I’m not trying to argue what the best option is, but rather to encourage you to do your own research and make more informed decisions. Although there is always general advice that’s good for most people, there are always specifics to each person’s individual situation and preferences; the best solution for person A may not be the same for person B.
Freetrade is expanding into Europe soon - if you want to understand the competition as a FT investor, DeGiro is a good, representative example of what FT is up against. So I’m going to examine DeGiro against the criteria I will set out below, so you can see how I would go about considering it as my broker (spoiler alert, I don’t use DeGiro.)
You’ll notice 2 underlying themes through my thoughts in this post. As with many money-related matters:
Up to a point, “You get what you pay for” and
“There’s no such thing as a free lunch.”
With that out of the way, here are some things to consider.
- Country Where do I live and where is my broker based? This is important for several considerations, but chiefly for financial regulation and taxation. Perhaps you live in country A and your broker is based in country B, which might give rise to considerations like:
- Paying witholding taxes (or equivalent taxes applied to foreigners)
- Additional paperwork to file when doing your tax returns, because you have investments made through a foreign broker
- Lower/higher investment compensation limits by your brokers regulatory authority
- Lower/higher regulatory standards or requirements for your broker’s regulatory authority
- Not being a native speaker of the language in your broker’s country
- Lack of residence in the country if the time comes to go to court/travel there for some other legal process
- Etc etc, you get the idea.
DeGiro (Netherlands) as a UK citizen
- Double taxation treaties are in place between the Netherlands and the UK, so this looks alright, but I haven’t read them in-depth.
- Yep! If the dividends from your portfolio are above £300, or if you exceed your capital gains allowance in a given year (you can forget about ISAs because DeGiro has been “working on it” for almost 3 years now.) No tax wrapper and extra paperwork? No thanks!
- The Dutch investor compensation scheme covers you up to €20,000. The UK wins hands down here, with the FSCS covering investments up to £85,000, increased from £50,000 last tax year. No contest. Point to the UK.
- Hm, this is a bit more complicated. Mifid II has to be complied with by Degiro, who are regulated through the AFM. It also has to be complied with by UK brokers, who are regulated by the FCA. Ultimately this boils down to if you think either regulator suffers from competency issues, and the recent £236m LCF scandal doesn’t exactly instill me with confidence in the FCA having my back. If we were comparing banks, it would be no contest (FCA bank regulation is much more stringent.) However I don’t know much about the AFM in relation to brokers, so we’ll call this one a tie.
- Yes yes yes, I’m aware that the Dutch are famously some of the most multilingual people in the world, but what if some problem arises and I need to go through some procedure (law court, tax court) where speaking the local language would be advantageous? Everything is easier if you reside in the country: HMRC (the taxman) knows who you are, you can drive 20 minutes to your nearest tax advisor, investment advisor or lawyer, not to mention all the international bureaucracy and red tape that will have to be cut through if things go south. Especially if it’s happening abroad! Sorry, I’m just not confident on this front; everything is easier if you stick to someone who operates in your “home turf,” so to speak, with a registered headquarters and regulated in this country (and/or in multiple ones.) Point goes to a UK-registered broker.
Oh by the way, here’s a legal hypothetical; I couldn’t find much in the way of corroboration of this article, but DeGiro uses a European Union rule (link to the full article here) to provide services to the UK. After Brexit goes through (if/however it does), what if DeGiro are barred from offering financial products to UK citizens, or have to reapply? Or, perhaps more likely, what if there are tariffs/fees levied on them by the UK which they then pass on to you? Would they still be a cost-effective broker if their charges went up 50%, given the size of your savings?
- Product What investment product or products will I use to invest? A huge reason why there are so many different brokers is because they occupy so many different niches and have competitive advantages in what they offer.
Bells and whistles aside, no broker in Europe comes close to offering the range of financial products at the prices DeGiro offers yet (wink wink nudge nudge.) Degiro have been offering “free” ETF purchases pretty much since inception, which is a big part of how they hoovered up so much European market share to start with. Point to DeGiro.
- Price This one is straightforward enough, the lower the better right? Well, remember: “you get what you pay for,” and “there’s no such thing as a free lunch.” Cheap brokers are cheap for a reason, it’s up to you to sniff out exactly why. Where are they reducing your costs as a customer, if not only in their profit margins? These reasons might include (but are not limited to)
- Absence of premium features e.g. investment data, tax-related advice or help (e.g. regular account statements,) dividend reinvestment programs, tax-wrapped accounts (we mentioned ISAs before) etc. etc.
- Stock lending (see below)
- Low credit quality (riskier) “custodian” to hold your shares in deposit (see Safety section below)
- Omnibus accounts (see Safety section below)
- Wider spreads on things like currency
- Other “hidden” fees (we’ll get onto my opinion on things like high frequency trading below)
- Crappier IT infrastructure in both the front end (the website, the mobile app) and back (servers, technicians, processing and executing orders, etc.)
- Security: how safe is your money from hacking or fraud, or the likes? (see Safety section below);
- Poor customer service; if you have encounter a problem, are you screwed/on your own?
Freetrade would be the only clear single competitor in terms of price here (if you could only pick 1 broker) but I’m not counting FT as a competitor until all its upcoming features (namely ISA accounts for all users, European access and a greatly increased choice of shares) are live. Once FT goes through its next evolution, the best solution from a strictly price-evaluated basis would be a combination of platforms, including FT and others, depending on order execution and which financial products you wanted to trade in. DeGiro would lose it’s #1 position to FT for many European retail investors, many of whom are on the younger side. For now though, let’s throw DeGiro a bone and say they keep their top spot for their wide range of cheap products and once-a-month free ETFs.
But, remember all the stuff above all that. There’s no such thing as free!
- Guilty of all these except the account fees, if you look at sites like Trustpilot or on the Google Play Store you can see a lot of unhappy people, and surprise surprise, we covered a lot of their grievances already!
- Wider Bid-Ask spreads/HFT/in-house matching are harder to analyse without both being a customer and having access to a $24,000/year Bloomberg terminal. Luckily for me, someone had this idea already, and boy, it doesn’t look good for DeGiro.
This is completely f*cked if it’s true. I could write a post twice the length of this one on how messed up this is, but it’s much much worse than run-of-the-mill high frequency trading/front-running, it’s arguably worse than Robinhood.
High frequency trading
To explain why the above is worse than regular HFT, and for people to understand DeGiro’s frankly hilarious rebuttal, let me briefly explain what HFT is, because it’s confusing. Let’s assume there are no trading fees. You want to buy 5 shares of Apple, and you see that the “Ask” price (this is the lowest price that someone is willing to sell Apple shares at) is $100. Let’s assume that your broker’s “best execution policy,” which you’ve agreed to, allows you to spend more than $100 if it can’t find any Apple shares at that exact price (spoiler alert, it won’t.) You hit the “buy” button, and your order comes back; you bought your 5 shares, but at a cost of $100.05 each.
Essentially what’s happened is a so-called “high-frequency trading” firm, using incredibly fast connections right next to the exchange(s) where you bought your shares, has essentially “seen” your buy order coming, bought the 5 shares you wanted ahead-of-you for $100, and sold them back to you for $100.05. We’re talking billionths-of-a-second-fast connections. In fact, soon after they realised they could “race” signals from banks, mutual funds and other financial institutions that buy and sell shares, these HFT firms decided to drop the charade and just straight-up pay those institutions to send them customer orders, without having to compete against all the other HFT firms that were doing the same thing. This is a gross oversimplification, but it’s enough to illustrate the principle. These HFT firms pay (present tense) $100s of millions per quarter in the US to brokerages and banks for your orders, so you can imagine how valuable the information is to them.
However the landscape of HFT has gotten more-and-more competitive year-on-year, to the point where barriers to entry are immense because of cost savings from economies of scale, and so a handful of the larger survivors compete fiercely for tiny profit margins per share (we’re talking tenths of a cent.) Here is a breakdown of US broker TD Ameritrade’s payments from HFTs for the first quarter of 2019 (you can see they are getting paid as little as $0.0013/share, even though it adds up.)
Personally, I’d be completely OK with FT using HFT firms as market makers if it enabled them to provide their full suite of services; after all this is a company that needs to keep the lights on, pay its employees, keep a wide range of investment options open at 0 up-front cost to consumers, and (ultimately), become and stay profitable. Also if you’re depositing, let’s say, £400 a month into your Freetrade account and paying perhaps £0.40 above “market” (in aggregate) for the shares that you buy, would you deem that significant? Would you consider it a fair price for having access to exchanges all around the world? What if you were depositing £4000 a month, would you feel differently? In a way I think costs deducted this way are almost ideally suited to any “low”-budget investor; it’s a “pay-as-you-go” charge incurred as you invest the money that you’re able to save that particular week, or month, without having to worry about larger, monthly costs that eat into your portfolio no matter what. This will probably prove to be a vastly unpopular opinion, but we’ll see. Like I said, “there is no such thing as a fr” - ok, ok, you get it! I’ll stop.
If you can’t be bothered to read anymore, maybe chill out and watch this video on high frequency trading from the president of IEX (yes, that same IEX that Freetrade gets its price info from)
So the Dutch individual in that “DeGiro is screwing its clients” article established, with the use of a friend and a Bloomberg terminal, that he had the highest bid on the market at that time. DeGiro claims to match buyers and sellers using it’s “inhouse matching functionality” if they both use DeGiro’s platform, as per its order execution policy. His friend then put in a sell offer at the same price. Not only were they not sold to our buyer, who had the highest/supposedly the ONLY bid, but they weren’t sold on the exchange. They were sold to a mysterious third party, also on DeGiro. He claims that (presumably for a large fee) DeGiro is selling his order to a hedge fund, HiQ, an institutional client of DeGiro! And instead of paying 0.05% more to get his Apple shares, like we did in our example earlier, he’s not getting anything, because HiQ knows that he wants the shares; if he wants them, he’s going to have to bid more, probably up to the maximum of the spread (€0.11.)
This is much worse for your end users than selling your customers’ order flow to a selection of HFTs, because at least they compete aggressively on price, and constantly. In this case, one party (allegedly) has a monopoly on the information, so they can rip people off for more every time someone wants to make a trade. You might have overpaid by 2% per year across your investments instead of .02%, and you wouldn’t even know it!
Also from DeGiro’s Q1 2018 report “As of the 3rd of January, DEGIRO stopped executing orders internally…Two active professional clients frequently used this order type… This caused a decrease in the number of transactions from 530,074 to 65,318.” I wonder if HiQ was one of these clients, and how many of those trades were against DeGiro investors, hm… only took them 3 years to stop doing it, anyway!
- Crappier IT infrastructure: I can’t comment on this one, as I’m not a user, but on Trustpilot there are a lot of unhappy campers when it comes to DeGiro’s visual layouts/info on the app, it seems.
- Security: Again, no idea. If any of you use DeGiro I’d appreciate your feedback on this.
- Poor customer service: Again, read through reviews that you have available to you (I don’t have access to the App store, for example,) but most of the complaints seem to be regarding limitations of the app or customer service issues.
It’s amazing how much energy people spend thinking/calculating/researching a long-term, cautious-enough investment strategy, and don’t give a second thought to a much more basic question: 1) Where are my shares actually kept and 2) are they safe?
Once you purchase shares, they’re generally kept “under custody” by your broker’s custodian bank. In the UK, at least (from limited experience auditing some investment LLCs), any cash you deposit with your broker goes into a designated “client money” account, usually with a well-capitalised bank. You can check the safety of your funds under your custodian by checking it’s
- Credit rating (banks), although they were manipulated plenty during the financial crisis (see here)
- Financial regulator: We’ve done this already
- Investor compensation scheme: Likewise, already done.
- Capital adequacy ratio (CAR): Essentially the higher, the better, so they have more cash to pay their obligations (namely YOU) in case things get nasty. Under Basel III in the UK and Europe and the Dodd-Frank act, banks have to adhere to a whole host of requirements, including minimum CARs and stress testing. Basically if your shares are being held by a bank, you’re as protected as you realistically can be.
- Publicly traded: When you IPO, there’s a whole extra level of legal and financial hurdles you have to jump through in order to be able to tap the funds of the investing public - stricter regulatory requirements, closer scrutiny, more transparency, etc. If your broker is publicly traded it should relieve some of your worries.
Additionally, the type of account your shares are held in is worth noting; generally when you buy individual shares of your home country through a native broker the ownership certificate is in your name. When you buy international shares, (or even ETFs) more often than not they’re held on your behalf in an Omnibus account (basically a big pooled account.) The shares will be under the name of your broker, or a separate company with a slightly different name. Your broker then keeps an internal register of who owns what.
Omnibus accounts save brokers a lot of headache as they involve less paperwork, amongst other things, so you’re going to get these (I’d bet) at almost any broker you use. Ideally you’d want the shares in your own name in case things go wrong and your broker starts doing shady things like dipping into client money to pay its other liabilities. That internal share register might easily get “lost” if it suits the needs of the embezzlers and they need to cover their tracks/stall for time cough Enron cough. If there was a Sarbanes-Oxley equivalent in the UK that was enforced as handedly, the guys who ran LCF would be screwed for trying to destroy evidence. Again, pretty much all brokers I’m familiar with use Omnibus accounts, so no real getting around this one.
- Eh… so it turns out DeGiro holds all of it’s clients shares in two of it’s own “Special Purpose Vehicles”, referred to as SPV throughout its terms and conditions. Remember all that criteria i just wrote about credit ratings and whatnot? Yeah, forget that. There are no reputable credit checks done on these things.
- DeGiro publicly traded? Nope, no extra peace of mind for you.
- And then, the icing on the cake (CARs.)
So what are those exactly? Well, their 2018 Annual Results are no help. But from what I can gather from older account filings + my own research, the minimum capital requirement is:
HAHAHAHAHAHAHA, what?? So it turns out in Ireland (page 2) and the UK (Section 11.3.1) it appears to be the same. Taking a step back, I suppose you’re only protected up to £85,000, but I guess Basel III doesn’t apply to whatever these “investment vehicles” are. A senior bank executive could embezzle £50m at any decently-sized bank and it would still have enough cash in reserve to pay the SPVs entire capital requirement to 100 different investors every day for a month.
Some of you will have more in savings than the entire minimum capitalisation of your broker. I don’t know about you, but that’s a little scary. Maybe if DeGiro didn’t miss so many other boxes I could swallow this, but as it stands, no chance.
- Share lending
A lot of you, even if you are active traders moving in and out of positions every day, will have a significant amount of your portfolio in “buy and hold” assets. These shares (or whatever) might easily sit your account for years. Some brokers use the more stable balances of shares in their Omnibus accounts for lending, in return for interest payments that they can profit off of.
You guessed it!: under sections 9.1 and 9.2 of the Client Agreement, unless you’re willing to pay DeGiro a premium each month for a “Custody Account,” they’re gonna lend your shares out! And sure, you can pay a little to hold onto any shares that you own, but it’s not such a “free” broker now, is it?
Finance/money management/accounting can be dense enough at the best of times, and in a few years most of your life savings could be tied up in investments you make with your broker, so a little bit of research won’t do you any harm.
Well, sorry for the long read, but I hope some aspect of it somewhere has been useful! Always do your homework; nobody cares about your future as much as you do. And with all that being said, DeGiro could be a perfectly serviceable broker for you, depending on your outlook regarding all these things, and if you’re happy to stick within the €20,000 limit for example.