Which Online Broker to Choose?

Online brokers vary quite a bit in their features and services, so choosing the one that is best for you out of the fourteen available may require some comparison shopping. Here's my suggested shopping list.

1) Does the broker offer all the Account types (RRSPs/RIFs, RESPs, LIRAs/LRIFs, Trust accounts) and choice of Securities (mutual funds, fixed income) you need?

2) Are Fees and Commissions competitive? Compare:

• trading fees / commissions - the cost per share or per trade for buy/sell transactions; the rate may be much lower with a larger account balance
  
• administration fees - for account balances below a minimum size, there is often a quarterly or annual charge
• bond commissions - you pay a commission buried in the price when buying and selling bonds as Rob Carrick of the Globe and Mail explains; it's hard to compare brokers for that reason but see some of the blogs below for discussion
• foreign exchange - when trading US stocks or bonds it is necessary to convert to/from Canadian dollars; the broker will do it for you but you pay an implicit commission through the exchange rate charged. Within registered accounts like RRSPs, a few brokers allow you to keep a US dollar cash balance, which is advantageous if you intend to sell a US stock and then buy another since you avoid a round trip through Canadian dollars with a commission on each leg of that round trip.

3) How much will you need Tools and Research like stock data, news feeds, analyst reports, sorting and ranking tools and personal financial planning aids such as investor education documents, retirement planners, asset allocation and portfolio design tools?

4) Have a look at each broker's website to see if the Website Interface and Usability will make it frustrating or easy to invest.

5) Happily, Online Security and Investor Protection are uniformly good enough all round in my opinion to remove those as make-or-break worries about brokers.

6) Is live telephone Customer Service there when you need to fix problems with minimum hassle or carry out special non-automated transactions? Opinions on the brokers vary, so read the blogs and newspaper reviews and take none as the ultimate answer.

7) Are you best with a Best-of-Breed broker or One-Stop-Shopping?
The independent brokers may have the lowest per share trading costs but the banks offer online integration with banking, simplifying tracking of investments and enabling quick movement of money among accounts.

Assessments and Ratings

• Stingy Investor has a list of Canadian discount brokerages with their trading commissions and links to the broker websites.
• Canadian DRIP Primer has a more up to date list of Canadian discount brokers.
  
• Canadian Capitalist briefly reviews many of the brokerages in linked posts
• Million Dollar Journey compares online brokers, focusing on the independents
• Rob Carrick of the Globe and Mail rated online brokerages back in Oct. 2007

I've been a client of BMO Investorline for over ten years and though they aren't perfect (US dollars in registered accounts please!), I've discovered that the others are not either. BMOIL does a very competent job for me and I can recommend them. I also have an RESP account with TD Waterhouse, where I've had a generally positive experience.

Finally, if you sign up with a broker and they don't serve you well, you can transfer to another broker.

BMO Investorline to Introduce RESP Accounts

BMO Investorline is to fix the anomaly of not offering Registered Education Savings Plan (RESP) accounts for its discount brokerage customers according to a recent note to clients from Connie Stefankiewicz, President & CEO. Good on them, it's about time. I am hoping it will facilitate online contributions with direct transfers of cash (dare we hope even contributions in kind?) from bank accounts or a regular trading account. The RESPs are to begin in "early fall".

Expat Canadians Investing While Abroad

What happens to investment accounts at Canadian brokerages when a Canadian goes out of the country to work or live? Would you want to be forced to transfer your investment accounts to another country for a few years in order to manage them or be obliged to leave them inactive?

For self-directed, self-managed investors, such a prospect can be particularly frustrating since technology enables Internet or telephone access to accounts from virtually anywhere. Unfortunately, the WWB (World Wide Bureaucracy) has complex rules that may bring a full stop to such activities. If you are not leaving permanently with your money/investments and you wish to keep your accounts open and available for trading, you need to be careful.

The issue arises from this fact taken from the Ontario Securities Commission note on Cross Border Trading:

"As a fundamental principle in securities regulation, for a securities broker to deal with a client, the broker needs to be registered with the securities authority in the jurisdiction where the client is resident. This applies in the individual states in the U.S. and in the provinces and territories of Canada."

So where are you considered to be "resident"? It all hinges on the meaning of that word resident, which is defined in different ways by different authorities, or even not at all explicitly, leaving the matter to the varying interpretation of court cases, to the utter frustration and dismay of us poor schmucks who have to figure it out.

Here is part of the OSC's response to my enquiry on the issue:
"The term "residency" is not defined in Ontario securities law. Where questions of jurisdiction are to be determined, it must be done on the basis of specific facts and not hypothetically. The basis of jurisdiction may be differently interpreted and applied in different jurisdictions. We cannot give you an opinion or interpretation of Ontario securities law, nor of any other jurisdiction."

The oft-quoted principle that being 183 days or more (i.e. more than half the year) in a place makes you a resident may not apply. A few years ago, Canadian snowbirds with RRSPS and RRIFs found that Canadian brokers refused to allow them to trade in those accounts. As a result of many protests, the US federal regulator, the Securities and Exchange Commission, made a special ruling outlined in the note Canadian Tax-Deferred Retirement Savings Accounts that exempts those type of accounts and allows Canadians to continue trading in them while in the US. It also contains this ominous statement,
"... federal securities laws generally require that securities transactions made for U.S. residents-even those in the U.S. for only a brief period of time-and brokers who sell those securities be registered with the SEC". What the "brief period of time" might be I do not know.

The SEC exemption that removed the restriction on trading in RRSPs and RRIFs did so only for those type of accounts. Regular taxable trading accounts are being blocked. I'm not 100% sure but I believe the reason Canadian brokerages have not fixed the problem simply by registering in both Canada and the USA is that the securities being traded must also be registered in the proper jurisdictions. In the case of the USA, the individual States also have registration requirements as the afore-mentioned SEC note says. Our cherished OSC sums it up nicely: "Due to the complexity of regulations and the confusion as to which states have accepted or partially accepted the SEC process, many compliance departments of Ontario registered brokers have decided that their firms will NOT transact any business from those customers while they are on US soil." Welcome to the WWB!

All this is supposedly motivated by a desire to protect the investor from fraud as paragraph 1.1(a) of the Ontario Securities Act says and this document Investing and the Internet by the OSC suggests. In the case of the USA, there are evidently other motives too, namely to protect the business of US investment firms - see III - Cost Benefit Analysis in the explanation of the ruling where it says the ruling will not significantly harm US brokers by taking away the potential business of Canadians forced to move their accounts to the US.

The brokers are the ones we must deal with and it is their interpretation and application of the law and regulation that counts in the end. Part of the OSC's response to me included this: "Dealers and advisers in Ontario have developed compliance policies to ensure they do not risk breaching the laws of foreign jurisdictions. These policies are not specifically prescribed by Ontario securities law and may vary from firm to firm."

One should therefore not expect that they will all do it the same but I was puzzled and amused by the discussion by several Canadians living in Japan on a Financial Webring thread describing their investing activities despite living outside Canada for many years. One broker evidently is deducting taxes at the rate for non-residents while continuing to allow trading. I am not familiar with securities regulation in Japan but perhaps trading is allowed to continue because there are no restrictions in Japan that Canadian brokers would violate and the broker knows that the Canadian regulator will in fact do nothing about it (the OSC's response to my enquiry left me the strong impression that the OSC would not care - they only mention the foreign jurisdiction problems). Or maybe different parts of the brokerage business don't communicate well enough to catch it. Or maybe the brokerage applies what the OSC also said in their response to my enquiry: "The citizenship and tax status of the investor is generally not relevant in applying Ontario securities law."

In the UK, so far as I could determine from two separate calls to the regulator, the Financial Services Authority, there is no legal restriction for UK brokers to deal with non-residents ... though phone calls to a couple of UK brokers also revealed that they will not open an account unless you are a UK resident. Maybe it's only the US that is an issue because only the US will punish the brokers.

Out of curiosity, I called BMO Investorline to ask how they deal with this stuff. According to the telephone rep I spoke to (who knows if it could be different in practise or with a different person), they rely on the investor to inform them through an address change notice, though they also suspend an account if signs show a person is gone or mail is returned. When pressed about when a person becomes a non-resident, they said they use the 183 days+ absence rule but they have no way of knowing the length of absences.

What to Do to Keep A Canadian Brokerage Account Happily Active.
Let us call this the benign neglect or the "See No Evil, Hear No Evil" approach. Ultimately it doesn't economic make sense for brokers to stop their clients trading - that's how they make their profits. So don't provoke them or force the issue.

1) Decide for yourself whether you are a Canadian resident for brokerage purposes (which is not the same as for tax purposes). If your answer is yes, Keep a Canadian Street Address to receive mailed statements and have an official location within Canada, not just a post office box, and if you need to inform the broker about a new address prior to leaving, make sure it is a province where the broker is registered
2) Do your trading online; it's cheaper and faster anyway

Bond Index ETF/Funds vs Bond Ladder

A little while back, Mike from QFP asked me to compare my experience using a bond ladder for the fixed income component of my portfolio versus bond funds, which I have just started using this year in the form of ETFs. Good question, here are my thoughts.

Bond Ladder
My holdings look like this:

• More than ten individual bonds;
• Different issuers, corporate only, none government, Canadian only, no foreign;
• Staggered Maturity approximately (at various times throughout the calendar year) one year apart, from 2008 up to 2026
• Held across two LIRAs and an RRSP
• No buy-sell, just buy and hold to maturity - when one matures I buy at the long end of 10+ years which gives higher yield - since I've been doing this, the yield curve hasn't gone upside down, where higher yields would be available for shorter term bonds
• Coupon bonds only, no strips or residuals
• Investment grade only

Observations:

1. Credit risk and diversification is merely ok but not great - I have too few bonds in too few categories to be properly diversified. Though I have bought only investment grade bonds, it happened once that one company had its debt rating lowered and the price took a big hit. It didn't actually go into default but that risk isn't negligible. I didn't lose any money because I held to maturity and the bond was repaid at par. A few years back, Telus had a bad patch, it got downgraded, I nervously bought a bit, management got the ship back on track and lo and behold, I made a very nice gain in addition of course to continually receiving the coupon payments. Nowadays, I'm taking the attitude that I won't presume to judge better the credit risks than Standard & Poors or Dominion Bond Rating Service.
   
2. Portfolio rebalancing is more difficult - since I have made myself a policy to rebalance my overall investment portfolio back to target percentage allocation (30% in fixed income) if it comes to pass that equities have a crappy year and I am overweight in fixed income, what should I do - which bond to sell and put a hole in the ladder? As well, bond buy-sell minimums might cause an asset allocation overshoot and the buy-sell spread/commission on bonds adds to costs.
3. Purchases are lumpy - the minimum bond purchase amount is $5,000 so you need a fairly hefty sum to even build a ladder. The smallest I have seen suggested is a ladder of five bonds, i.e. $25,000, though due to the above diversification considerations, I feel $50,000 is more like a proper minimum.
4. Limited inventory - the discount brokers don't have a huge selection. Yesterday, when I went through my TD Waterhouse account there was not a single corporate bond of more than eight years maturity. BMO Investorline had a much better inventory, but ...
5. Commissions can vary between discount brokers - I managed to find the same bond for sale at both BMOIL and TDW yesterday and discovered that BMOIL charges a higher commission than TDW. The GE Capital 4.4% 01JUN14 ask price for the min $5k purchase at BMOIL was 96.46 and 96.257 at TDW, a difference in commission of about 1% vs 0.76%. BMOIL = bigger inventory but higher commissions. TDW also supplies, very conveniently, both the bid/buy (94.757 in this case) and ask/sell prices, which is what allowed me to figure out the mid/average price and the commission.
6. Commissions and therefore costs can be low if bonds are held to maturity - though the commission on an equity trade of $10/5000 = 0.2% is much lower than the above bond example, there is no recurring admin or management cost on the bond and, if held to maturity, the cost averaged over years goes down to very small amounts, which Shakespeare's primer has conveniently calculated and graphed here. On the other hand, if you start actively buying and selling bonds, your commission costs will be quite high, i.e. my recommendation is that a bond ladder is for holding bonds to maturity.
7. Commissions do drop with larger purchases and your yield/return rises. For example, today on BMOIL, buying $100,000 of GE Capital DD Call 4.65% 11FEB15 gives a yield of 5.238% while the minimum purchase of $5,000 yields 5.117%, a difference of 0.121%. As they say here, every little helps. Do you have $1mill for your bond ladder to get that extra 0.1%? No? Then just buy another bond that yields slightly higher.
8. Choice of receiving the return as cash or an ultimate lump sum. Most bonds pay out cash as coupon interest payments every six months, though some do so every month, allowing one to tailor a cash flow if desired. In my case, I really should be buying stripped coupons and residuals instead of regular coupon bonds to avoid having the interest payments sitting idly in cash between my rebalancings and to lock in the yield aka avoid the reinvestment problem. (A really good brief explanation of stripped bonds is BMOIL's on their website at https://www1.bmoinvestorline.com/EducationCentre/FixedIncome/Products.html#3.1 or if you cannot access that page, see Shakespeare's explanation at the link above. I am still accumulating and not withdrawing from my registered plans so I don't want cash, but someone else in retirement and needing to withdraw cash might find that handy.
   

Bond ETFs

1. Diversification is easy and assured. With one purchase it is possible to acquire a large number of bonds to cover the whole Canadian market, like XBB, or subsets thereof to reduce individual company credit risks to their minimum. One can acquire a subset that apparently acts as a separate un-correlated asset class - real return bonds, like XRB. One can also buy foreign bonds, like the US dollar AGG, which I have done to further diversify my holdings, or even international bonds, though I have not done that yet. Read this GlobeInvestor article for a rundown of various US and international alternatives.
   
2. Rebalancing is easy and precise. Since the ETFs are like a stock, an asset allocation can be set almost to the dollar and it takes only one trade.
3. Management fees are a bit higher. The annual management fee on a fund, even if it is a passive index-tracking fund like the ones named above, takes a bit away from the return every year. MERs: XBB - 0.3%, XRB - 0.35%, AGG - 0.2%
4. Interest payments on bond ETFs are received in cash, with the same issues as discussed in the case of individual bonds. Bond mutual funds can reinvest the payments but their MERs are higher, which is a worse problem than receiving cash. If you have one giant holding in an ETF and receive a large cash payment, it may be enough to reinvest immediately instead of waiting months while a reasonable amount piles up.

Most of my fixed income portfolio is in the Canadian bond ladder, but I have smaller holdings in some of the bond ETFs mentioned to facilitate my asset allocation and rebalancing. For me, and I would suggest for anyone, tax considerations don't enter into the picture since my holdings are all in tax-deferred registered accounts. It doesn't make sense if one can possibly avoid it, to have any fixed income in a non-registered taxable account - it's always better to pay taxes later.

BMO Investorline and Foreign Exchange Trades in Registered Accounts

Little did I know when making this post complaining about BMO's policies regarding foreign exchange rates when buying and/or selling US securities in a registered account that much has already happened.

First, there was the $100 million dollar class action lawsuit launched back in August 2006 against BMO claiming that BMO has illegally forced customers to change foreign currency from Canadian dollars into US dollars or vice versa in registered accounts since June 2001 when the tax laws changed and began allowing foreign currency to be held in such accounts. You can register with the lawyers Paliare Rolland to be kept informed of the case's progress. Or you can sit back and keep an eye out for news, or just wait - I'm betting years - for a letter from BMO or the lawyer, saying the case has been settled for x amount and here is what you get.

The second development is the internal memo issued by BMO and reported by the Toronto Star in April this year to allow clients who trade in and out of US dollars on the same to take a single exchange rate for both the buy and the sell and thus avoid the buy-sell spread and/or any fees for the conversion. There is also a lower fee structure - down to 75 basis points (0.75%) or 70 basis points for all you folks who have trades over $30million. There isn't any notice or warning on the website about this situation, so BMO clients be aware - you must phone and ask for the single rate out of and into US dollars.

Maybe someday the big bank brokerages will manage to convince their software supplier to make the necessary changes to the program they all use in common to manage registered accounts. Apparently the bottleneck is the software and the supplier just won't change it (no it isn't Microsoft). Those of you at all familiar with the world of IT will not laugh and scorn but will quote the old saying, "God could not have created the world in seven days if he had had an installed base." Some who have had similar experience with the bugs that follow on new versions of software might just wisely note, "be careful of what you wish for, you just might get it."

BMO Investorline Modifies Foreign Currency Notice

Back on May 27th I posted this complaint about BMO Investorline's lack of disclosure with regard to the foreign exchange rates used when one trades in foreign securities, like those on US markets, on top of the fact that BMOIL does not allow foreign currency to be held within registered accounts, so making unjustified profits for BMOIL in the obligatory two-way currency exchange. Curiously, upon login to my account this morning, I discover that a new notice has suddenly appeared on BMOIL's webpage (see graphic).

Probably this is a coincidence since it is highly unusual for a big organization to make any change in response to an individual's complaint (large organizations by their nature only respond to an appropriately large stimulus, like losing a major lawsuit, getting into major financial problems etc). This notice doesn't provide any better disclosure, it merely says BMOIL can set whatever foreign exchange rates it likes on transactions. That neatly covers their liability, of course, which is BMOIL's primary objective. But it doesn't help investors trade accurately by having exact rates at the time of transactions. Nor does it seem fair for BMOIL to set whatever rates it likes, particularly since BMOIL only sets the rates at the end of the day, long after the trade has been committed. That BMOIL is trading the foreign currency for its own profit makes this unfairness even worse.

Another curiousity is that the link to the full agreement takes one to a pdf document dated March 2007. If there is something "new" in the agreement, wouldn't a more accurate date be June 2007, or is it allowed to retroactively change agreements? Just asking....

Frustrated with BMO Investorline "Disclosure" on Foreign Exchange Rates

It is my objective to write positive things in this blog and to ignore the negative as much as possible but a significant hidden trap I encountered at my broker BMO Investorline bears writing about.

When placing a trade in an RRSP or a LIRA for a security traded on a US exchange, the BMO Investorline online web page first gives an Equity Order Review screen before the final purchase is submitted on entry of the password. My graphic shows a screen capture of such a real screen in which I set up a potentially real order in one of my accounts. Note the use of the word "estimated" in reference to the US order value and the final Total order value in Canadian funds. What does "estimated" mean in this context? Part of the meaning is that, as it says right on the screen below, the current market price is only indicative and may change on such orders placed at market price, between the time of order entry and the moment when the order hits the market. That's ok, stated and understood. Then there is the estimated Canadian dollar price, which depends on the exchange rate and one could presume as well that the rate could change in the time it takes to commit the order. However, there is nothing on the website, and I checked by phoning a BMOIL representative, that gives an accurate explanation of what "estimated" really means. It turns out that the meaning of "estimated" is significantly different, and negatively so, for the investor.

The reality of "estimated" is as follows:

• the C$ to US$ exchange rate is not a buy rate for a US equity purchase nor a sell rate for a US equity sale, it is a mid-market rate;
• the actual exchange rate applied to any purchase or sale is the buy or sell rate at the close of markets each day.

To repeat, nowhere are these critical details available to the investor.

What are the negative effects?

• an investor can never know exactly how much a purchase will cost or a sale will bring, making it impossible to quickly make a series of investments that will leave an account with a target cash balance. Isn't it a fundamental consumer right to know what something will cost before making a transaction? There's the double problem of the mid-market rate and the delayed rate. In this case BMOIL does even disclose the basis on which the ultimate price will be based.
• all purchases will be systematically under-estimated, that is, will cost more in Canadian dollars, and all sales will be over-estimated, i.e. bring less in after conversion. This happens because the mid-market exchange rate is an average of the buy and the sell rate so it will always be high for one (sales) and low for the other. The effect is significant since the spread between buy and sell rates is over 1.8% for me at BMOIL, thus over 0.9% on each trade.
  
• as a result of these two factors, a couple of my accounts ended up in minus balance, a rather nasty surprise. The ironic twist to the story is that registered accounts are not, according to the BMOIL rep I spoke to, allowed to go into negative balance. During the live real-time trading that didn't show up, as evidently the automated "you are not allowed to do that trade because your account will be over-drawn" piece of software, also relies on the estimated order value. The rep also assured me I wouldn't have to pay interest on the negative balance..... good thing they record those voice conversations with clients, huh? Hmmm, think I will leave that negative balance there till next year when I do my next re-balancing.
  

Consider a few other points:

1. the estimated mid-market rates on my purchases or sales varied with each trade; obviously therefore, that number is being updated constantly as markets change. The mid-market is an artificial computed rate between the buy and the sell, which are the only real rates. If BMOIL can supply in real time with each trade the mid-market rate, it must also have available the buy and the sell rates in real time. Why cannot it therefore apply this rate to the trade? I believe BMOIL is acting as principal in these foreign exchange transactions with clients, which leaves even less excuse for it not giving an instantaneous, committed exchange rate.
2. the main source of this whole problem is BMOIL's decision to allow only Canadian dollar cash within any registered account and to force all US transactions to go through the buy and sell of foreign exchange (on which it makes money!). There is no requirement for this at all, certainly no legal restriction since the lifting of foreign content limits a few years ago. One wonders what the practical restrictions are too. My regular open BMOIL account has a Canadian and a US dollar side and I can settle trades within an account, or make online, real time transfers between the two sides, which of course again confirms that the buy and sell rates are readily available.
   

How to deal with this? First, it's worth asking the brokerage exactly how the foreign exchange rate is calculated. Second, at BMOIL on a buy it is necessary to add about 1% to the Canadian $ cost of US purchases or subtract 1% from US sales and then to leave margin for currency changes by the end of the business day. If trading at market prices, maybe it's worth waiting till near the end of the trading day to lessen the time the currency has to change.

I suppose I should have noticed before since I have bought and sold US equities previously in RRSP and LIRA accounts and I suppose one should always on principle be wary and questioning of the way things work to avoid nasty surprises. However, the almost total lack of disclosure and the appreciable negative consequences resulting from a poorly designed trading tool leave me frustrated and annoyed to say the least. We'll see how BMOIL responds after I send them a letter of complaint.

iShares Distribution Reinvestment vs DRIP

A follow-on to yesterday's post about Exchange Traded Funds (ETFs) is another perhaps confusing characteristic regarding distributions and reinvestments. As the blue highlighted area of this table shows for the Canadian iShares ETFs, in 2006 there were both cash distributions and reinvested distributions paid on a number of the ETFs. The cash distributions are actually paid out to the owners of each ETF at the end of each quarter just like dividends of any other company stock (with shareholders of record date for eligibility etc). An iShares press release gives the amounts for the 2007 March end quarter. For buy and hold investors like me, I don't need the cash/dividend to pay everyday expenses and I would rather that all the money be reinvested with the least cost and effort. Unlike many companies which have Dividend Reinvestment Programs (DRIP) that allow any dividends paid out to be automatically used to buy extra shares without brokerage fees, iShares cannot do so itself with its cash distributions as it explains on this FAQ page, though it says that brokers might provide the service (and it seems that Canadian ShareOwner Investment Inc is one that will but mine - BMO Investorline - will not ... hint, hint).

Stingy Investor has a very handy page listing all the Canadian companies with DRIPs (and related things like Stock Purchase Plans) for those who are interested.

BMO Investorline Lowers Some Trading Fees

It's nice to read that discount BMO Investorline is lowering its equity trading fees to $9.95 per trade for all telephone or online automated trades as of March 31st on both Canadian and US exchanges. See http://www.bmoinvestorline.com/ProductsServices/5Star.html. That's a big drop from the existing $25 for market orders. Unfortunately, this applies only to what it calls Gold Star clients who have combined assets with BMO of $500k or more. Canada has for years lagged behind the US in low trading fees so maybe this is the start of a change that will extend to all clients. Anyone know if the other major discount brokers in Canada are following suit?