How Much Should You Consider a Brokerage's Reputation?

May 13, 2013, 2:17:04 PM EDT

When it comes to keeping your money safe, and that certainly still matters when you're making investments, often the biggest names provide a sense of security that discount options simply can't match. The fact that these businesses are as large as they are seems to indicate that they must be reliable.

The recent financial crisis has dissuaded some people from this line of thinking, but the question of how much you should be considering reputation when you're comparing online brokers remains. As much as people might want to find good deals, and are suddenly a bit warier of some of the big players, the potential for fraud or simply poor service still exists.

Avoiding fraudsters
The most important step in a brokerage comparison is to weed out any potentially rotten fruit. Though they are rare, scandals crop up in the news every year. In 2012, Peregrine Financial Group was shut down after the revelation of massive misuse of investor funds, and the year before similar abuses caused the collapse of MF Global.

The biggest key to avoiding these types of situations is to carefully look into the history and public perception of whatever brokerage you have settled on based on other factors. This type of thorough background check can come earlier in the process, but you should be absolutely certain to read up on a firm before committing.

Probably the most important source to check is simply the news. The Wall Street Journal notes that Peregrine had come under regulatory scrutiny in the past, and MF Global had also been fined in the years before its fall, both of which should serve as warning signs for investors. Similarly, any significant lawsuits can indicate how serious potential concerns might be.

But the more general reputation is also important for an online broker. You can get a rough sense of public perception by browsing through message boards, social media and industry monitoring sites.

Keep in mind that, oftentimes, complaints about unfair practices at various brokers are nothing more than sour grapes. Many traders are unsuccessful for a wide variety of a different reasons, most of which can be pinned firmly on their own mistakes, but plenty of people are loathe to admit their own failures.

Be sure to think logically about the claims people are making, and try to weigh whether they sound like a systemic problem or just an excuse. One helpful hint can be whether these complaints are widespread or seem to only target one or two truly unfortunate traders.

Testing your assessment
Once you've decided on a broker you're comfortable with, it's time to see how good your judgment really is.

Especially for new traders, most experts recommend starting small and working up to serious investing. But even with relative veterans, when you're starting with a new broker you should try to test out the service by creating a small-scale account.

By spending a month or two trading, taking advantage of the various services advertised on the site and asking for the help, you can get a reasonable measure of how the firm treats its customers. Finally, when you're done with your test, try to close out your account and see how you are treated once you are no longer a prospective customer. Both of these scenarios can tell you a lot about what to expect with larger investments and should give you a reasonable chance of avoiding the worst offenders.

Ultimately, reputation among online brokers is only modestly important, since many large and well-respected firms are still relatively unknown in the general public. Putting services to the test is a more reliable approach.

Research your brokers before you trade

Want to trade FX?