Tuesday, 22 May 2012

When not to use the cheapest broker (i.e. Interactive Brokers)

One of the earliest missions I went on with this blog was to find the best value broker around.  They not only needed to be cheap but they also needed to offer the full suite of investment products.  I ended up settling on Interactive Brokers and I have been surprised at how good a trading platform it has been - in fact I would recommend it to anyone who is serious about trading.

One of their enduring faults however (as I have posted about before) is their inability to participate in dividend reinvestment plans.  While this has annoyed me it has never caused me to want to use my other broker who is much more expensive (an Interactive Brokers trade costs me A$6.00 for an ASX trade and costs me A$29.95 with Commsec - my old broker).  Late last week however I came across a situation which caused me to rethink this 'cheap only' policy and I actually used my old Commsec broker.

The stock I was buying had a high dividend yield (~8.5%), I was looking to buy a relatively large portion (~$10,000 worth) and had a dividend reinvestment plan with a 2.5% discount associated with it.  Assuming I held the stock for 5 years (I don't really like quick trades) this is the difference in the outcomes

Interactive Brokers
  • Stock purchase price (including trading costs): $10,006
  • Dividends (assuming no increases in dividends): $4,250 cash
  • Cash received after selling stock (assuming no increase in price and including trading costs): $9,994
  • Total return = (9,994 + 4,250) / 10,006 = 42.35%
  • Stock purchase price (including trading costs): $10,030
  • Dividends paid in stock (get the benefit of 2.5% discount): $4356.25
  • Cash received after selling stock (assuming no increase in price and including trading costs): $14,356
  • Total return = 14,356 / 10,030 = 43.13%
I realise that this is a very simplistic comparison and that if the stock price went down over the period that this would influence the decision and also that it depends on the return that the cash dividend would get vs the stock.  I would argue however that an 8.5% yield is pretty hard to match with any other instrument or stock with any degree of certainty so assuming the stock price didn't move this would be a much better yielding investment.  I should also emphasise that the smaller the value of your trade the less significant this difference is going to be.  On a $1,000 trade the value of the dividend discount is going to be totally outweighed by the trading cost difference.

On a per annum basis the difference is minimal (less than 0.2% p.a.) but if you already have a trading account set up the consider keeping it open.  This is especially true if your broker does not charge you fees if you don't trade and allows you to participate in these types of issues.

If anyone would like me to do it - I can upload an excel file with a more robust calculation so you can see when it is an advantage to trade through interactive brokers or your own broker in situations such as this.

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