Shares are back in vogue; now cut the cost of trading

Cheaper online dealing can boost returns from a stronger market, says David Prosser

More than four years after the UK stock market began climbing back from rock bottom, investors have finally begun buying shares again. The latest figures from Compeer, which conducts regular surveys of how many investors are dealing directly on the stock market - rather than using funds - show that the number of trades has doubled to 50,000 a day since the end of last year.

The bad news is that, with investors staying out of the market over the past five years, share dealing firms have been struggling to keep their heads above water rather than spending time thinking about product innovation or modernisation. Critics of the stockbroking industry - including some who are in the business - warn that charges remain overexpensive and overcomplicated.

As a result, there's a real danger that investors who don't choose their broker carefully could end up paying thousands of pounds too much in charges every year, substantially reducing the potential profits on offer, even assuming that share prices keep rising.

Michael Foulkes, the chief executive of TD Waterhouse, the Canadian broker that is vying with rivals such as Barclays, NatWest and Halifax for the biggest share of the UK's stockbroking market, says commissions must come down. It charges £12.50 for each trade - buying or selling - in the UK, considerably more than its sister companies in North America.

"Until now, dealing volumes have not been sufficient to enable most brokers to cut charges," Foulkes says. "As a result, UK investors pay significantly more to trade than their counterparts in the United States and Canada."

However, there are still bargains to be found. Hoodless Brennan, a smaller broker based in London, launched its flat-fee dealing service in 2003 and has charged just £7 for online trades ever since, comfortably undercutting its rivals.

"We first launched an internet dealing service in 2001, with commissions charged as a percentage of deal sizes," says Mike Rayden, online trading manager at Hoodless. "What we quickly realised was that clients were looking for the simplest charging structure possible, which is why we switched to flat fees."

There's no doubt that the majority of brokers are still getting away with overcomplicated charges. The first issue with which investors must grapple is basic commission charges. Hoodless is unusual in charging a flat fee - many brokers' fees are a percentage of the value of the trade you're making.

This means that investors placing large trades lose out - and as there is usually a minimum charge, small deals can be expensive too.

On top of what you pay on each trade, many brokers have administration fees ranging from a few pounds each quarter to annual charges of £100 or more. The headline dealing commissions advertised by brokers can therefore be meaningless. Instead, investors need to think about how often they will trade - and what size deals are likely to be - and then calculate the total level of charges they will pay over a given period; say, a year.

That calculation produces huge variations. Moneysupermarket, the online price comparison service, monitors more than 100 execution-only stockbrokers. Buying one share a month online, assuming an investment of £500 each time, would cost just £77 over a year at Hoodless, according to Moneysupermarket. The most expensive broker in its tables would charge £296 for the same services.

To make the picture even more complicated, some brokers charge "inactivity" fees - if you don't trade regularly, your quarterly administration charges will increase. At the other end of the scale, frequent traders may be able to negotiate a better deal; Barclays Stockbrokers, for example, charges £12 for each online trade, but this falls to £7.50 after you have made 10 trades in a quarter.

Barclays' Emma Rees says: "It's true that people charge in different ways so you need to work out how your investment behaviour fits with the various pricing structures."

Even so, there are some basic rules. The cheapest way to deal is over the internet. Barclays says online investors now account for four-fifths of trades, but expect to pay extra if you want to deal by phone and possibly more for postal services.

Similarly, you'll generally only get the cheaper rates if you are prepared to sign up for a broker's nominee services, which means giving up paper share certificates. Hargreaves Lansdown Stockbrokers, for example, charges a flat rate of £9.95 for online nominee account dealing, but this rises to 1 per cent of the value of your trade, subject to a £15 minimum, if you want to deal using share certificates.

Many people do. "Lots of investors are attached to share certificates," says Paul Dimambro of Hargreaves. "People like holding something physical, it's easy to claim shareholder rights and perks, and many people have got used to dealing this way following the privatisations and demutualisations of the Eighties and Nineties."

It's worth trying to get your choice of broker right first time, since many firms charge exit fees when customers take their business elsewhere. Your new broker may be prepared to cover some or all of such fees - a charge of £10 to £15 for each stock is typical - but there are no guarantees.

Price is not the only issue to consider. You need a broker with robust systems and efficient administration - cheap fees will be no consolation if it is difficult to trade, or your account is mishandled in some way.

Online investors should also compare the research facilities on offer. Brokers provide all sorts of data and information to help investors make stock-picking decisions - some of this is freely available to anyone browsing the site, but at most firms, only customers will have access to everything available. If you conduct extensive research, or using graphing facilities, for example, to choose stocks, this may be an issue.

Finally, do you only want to deal in UK-listed shares? Most of the cheapest online brokers, including Hoodless, have limited international dealing facilities, or charge extra.

The bigger brokers, such as TD and Barclays, may be better value if you want full access to markets in Europe, the US and the Far East.

The different services on offer

Most stockbrokers offer up three types of service. There are also three ways to hold your shares.

* Execution-only services are for investors who know which shares they want to trade, without any professional advice. You give your instructions online or by phone and the trade is executed on your behalf.

* Advisory services are for investors who want to maintain control, but also want guidance on stock selection. Brokers can offer recommendations and advice on portfolio construction, as well as tax planning.

* Discretionary services are for investors who would rather hand over their money to a broker, who will then construct a portfolio in line with their goals and attitude to risk.

* Traditionally, investors who bought shares were sent a certificate as proof of purchase and ownership. It is still possible to trade this way but it is more expensive.

* Most brokers offer nominee services, where they hold shares electronically on your behalf. This is convenient, though it may make it difficult to claim basic shareholder rights, such as the right to vote at company meetings.

* The third way is sponsored membership of Crest, the Stock Exchange's electronic share settlement system. Not all brokers offer this option - and it can be pricey - but it enables you to hold shares electronically in your own name.