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The ABCs of online investing

An introduction to investing in mutual funds through an electronic broker

YOU'VE EARNED IT, FOUGHT for it, saved it. No one cares about your money more than you do. But if you're contemplating joining the ranks of the do-it-yourself online investor, the all-important question is: do you have the discipline, the time and the knowledge to effectively manage your mutual fund portfolio?

If you decide you have what it takes, a quick look at your peer group is in order. A composite sketch from sources in the United States and Canada reveals the typical online trader of stocks and mutual funds as male, college-educated, possibly self-employed and wealthier than the average investor.

E-investing, short for electronic investing, has evolved along with the World Wide Web. The emergence of discount brokers and the popularity of the Internet as a credible and seemingly bottomless source of investment information have given rise to do-it-yourself investing. The potential cost savings and practicality of the Web easily lead to the medium's transition from a research tool into a transaction tool for online investors. And it's not just the big banks and specialized electronic brokers who are offering online accounts. Many mid-tier and full-service brokers have created online extensions of their services, so customers can review their accounts and place transactions from anywhere.

Here are some of the advantages of managing your fund portfolio through an online broker:

  • Control. If you're knowledgeable about investments and are comfortable making and living with your own decisions, control over your portfolio should be an advantage. It's your portfolio and it's your job to make it grow. You're the one who researches funds and initiates buy and sell transactions. You're responsible for regular re-balancing. And, depending on your online broker's level of service, free advice, portfolio management applications and fund filtering tools may be available to help you keep your portfolio focused and growing.

  • Accessibility. You can take stock of your investments, review trading activity and initiate trades 24-hours-a-day, not just during daylight hours. The benefits of 24-hour accessibility are apparent if your day job limits you from keeping on top of the markets and keeping in touch with an investment advisor.

  • Convenience. Online brokers may promote and sell no-load funds as a value-added service, even though the broker receives no compensation from the fund company if you purchase these funds.

As Forrester Research predicted in 1997, the considerable advantages of online trading will hook more and more investors of mutual funds and stocks in the next few years. The U.S.-based research firm predicted that assets managed online will reach $688 billion (U.S.) in 2002, while the number of online trading accounts will jump to 14.4 million, up from three million in 1997. In Canada, the growth in the number of online stock and mutual fund accounts has been rapid. As the Web grows and online financial tools improve, the value of assets managed online is expected to rise.

Setting up an account

You must meet three requirements before opening an electronic account with an online broker. First, a computer with Internet access is a necessity. The second requirement is a 128-bit compatible Web browser, such as Netscape 3.0 or Internet Explorer 3.0 or higher. When you log on to your account, encryption technology encodes all data you transmit through your browser, much like a combination lock secures a safe. Your browser and your broker's trading system will agree on a "key" or combination, which allows the broker to unlock the messages you send while preventing others from looking in. As a result, the communication between your browser and your online broker remains private.

The third requirement is money. Some brokers require as little as $1,000 or securities of equivalent value to open an account.

Before opening an account, you must complete an application form and mail it to the brokerage firm. You can usually obtain an application online or request one by phone or email. A wide range of accounts is typically offered, including cash, margin, self-directed RRSP and U.S. dollar accounts. Once your application is approved, your online broker may equip you with customized trading software, a username and a login password. And trading can begin.

The typical interface for conducting online trades is straight forward and easy-to-use. You can search for or link to funds eligible for trading and get the latest fund quotes. To place an order, you will need the relevant fund codes and may need an additional password. You will also receive a confirmation number for each transaction. Account updates are made electronically once an order has been filled. Depending on the broker and the funds being traded, a transaction record and fund prospectus are usually mailed immediately or at month-end.

All about fees

Mutual fund fees are always a tricky subject. As commissions can differ widely, compare fees charged by several online brokers before making a decision to open an account. Some discount brokers charge zero commissions on fund purchases, but will penalize you if you sell a load fund within 90 days of purchasing it. Brokerage firms make money on the trailer fees paid out by load fund companies for providing advice and service to fund holders. Ninety days is usually the minimum time-period before a trailer fee payment is made.

Fees for switching, too, are worth comparing. Some brokers charge fees to investors who switch between funds in the same fund family. Others don't charge, as long as both funds have a similar load structure and management fee.

As with all back-end and deferred load funds, you will be penalized if you redeem earlier than scheduled. If you purchase no-load funds, however, you do not have to contend with early redemption penalties.

Understanding your investment personality

"If online investors are paying the same (trailer) fees as they would pay an advisor, why would they want to buy the product without the advice?" asks financial advisor Mardi Collins of Ottawa-based Sutherland Investment Corp. "I can't see why."

Collins has a point. If you buy a load fund that pays a trailer fee from a discount broker, you might not get the same quality advice that could be offered by a financial advisor. Some mutual fund companies that sell load funds, have complained in the past that clients who purchase funds through online brokers are phoning the company rather than the discount broker for handholding when times are tough or uncertain.

The solution begins and ends with you, the investor. Before choosing the do-it-yourself route, you should thoroughly understand your investment personality (conservative, growth-oriented) and craft a portfolio of equity and fixed-income funds that reflects your personality and investment horizon. Regular portfolio re-balancing and reassessment are also a must. To complement your own knowledge, you should determine to what extent you will need to lean on professionals for advice, and choose an online broker or financial advisor accordingly.

Many online investors manage only a small part of their portfolio and leave larger portions, perhaps their RRSPs, in the hands of an advisor. Others manage all their investments themselves. But what's crucial is that you manage your investments up to your level of comfort and expertise.

Make the most of the Web

It's essential for you as an online investor to capitalize on the Web as a research tool. Frequently updated Web sites such as GLOBEfund.com provide daily, monthly and historical mutual fund data. In addition, you can track your portfolio 24-hours-a-day, view comprehensive Fundlist Reports and isolate top performers using the Fund Filter. Also, you can view fund performance charts and graphically compare funds to benchmark indices and to competing funds.