NEW YORK (CNNfn) - When Fred Walker bought his first personal computer at the start of 1998, it was because he wanted to trade online.
Walker, now 67, had just retired as headmaster of The Williams School, a private school in Norfolk, Va. He figured he'd have a lot more time on his hands to manage his investments. What's more, his son's work had taken him to Belgium, but he was still getting part of his salary paid in the United States and wanted Walker to put that into the market.
Walker had worked with conventional brokers before, and had an account with Quick & Reilly in downtown Norfolk. He'd call in his instructions or pop by if he had paperwork to fill out. "But I was getting frustrated contacting them by phone. You get that, 'Quick & Reilly, please hold ...' thing," he said. It was driving him crazy. He knew he could trade cheaper online, too.
"I get better service this way than I did before, and I get it more reasonably"
-- online investor and retired headmaster Fred Walker
After a slow start with Quick & Reilly's QuickWay Net, which he found cumbersome, he switched his most-active accounts to TD Waterhouse.
He said he will never go back to a full-service broker. "I get better service this way than I did before, and I get it more reasonably," he said.
He hardly ever speaks to anyone at Waterhouse. "I don't need a person as long as the system works as well as it does," he said. "I certainly don't want anybody calling me up and recommending me to buy things."
The dream customer
In many ways, Walker is the kind of investor many online brokerages say they want to attract. Though he's not a very active investor, he trades more actively now than he used to before he went online. He has five or so retirement and personal accounts, and is also looking after money for his wife, son and several other relatives.
Walker is the kind of relatively high net-worth customer that online brokerages hope will consolidate their accounts with them. But analysts say they're not doing a particularly good job of appealing to them so far.
Online brokerages first targeted active investors, who generate a lot of commissions. They still appeal heavily to that community. To a large degree, they're the people that brokerages have in their minds when they design their accounts and online services.
"Active traders are important for a number of reasons," Fidelity Online Brokerage Executive Vice President Tracey Curvey said in a conference call, touting the brokerage's 3.5 million accounts and record performance in 1999. "They generate a significant part of our trading volume, they're demanding customers, they're early adopters, they're the leading edge, and they make us better at what we do."
"If you meet the needs of active traders, almost by definition you meet the needs of any customer that's interested in trading," added Gail McGovern, president of Fidelity Personal Investments.
"While frequent traders elicit special attention ... mainstream investors' choices are underwhelming."
-- Forrester Research analyst Ken Clemmer
But active investors only account for a tiny fraction of the investing public, said Ken Clemmer, an online-brokerage analyst with Forrester Research.
"Mainstream investors' choices are underwhelming," he wrote in a report late last year. Though brokerages often talk about tapping a larger, more mainstream market, they still appeal to the traders who trade the most first.
"Online brokerage has grown by appealing to the smallest, most aggressive, self-directed segments," Clemmer said. But he expects growth in that sector to be scant from here on, because almost all have already gone online with a broker. "There just aren't any of these people left."
New strategies needed this year
To attract more mainstream customers, Clemmer thinks online brokers need to offer more educational programs, more advice on investing basics. "Firms need to change what they're offering," Clemmer said. "Schwab is doing an excellent job of this, with the little classes they're running for folks -- this is what a P/E ratio is, this is what a limit order is."
But even Charles Schwab has its eyes on active traders. The same day that Fidelity, which targets the same wealthy, self-directed customers as Schwab, was announcing how they'd keep active traders happy, Schwab cut its fees for very active traders and bought a company that appeals to hyperactive traders. Schwab had previously positioned itself to go after mainstream investors with plenty of financial-planning tools and seminars for novice investors. Its founder and namesake has even frequently criticized very active traders.
Yet Schwab is cutting its fees from $29.95 a trade to $14.95 a trade for people who make more than 60 trades in a quarter. Trade more than 30 times in a quarter, and you get a rate of $19.95 a trade. For either scenario, you also have to meet the $50,000 account minimum.
To pay for the fee cut, Schwab actually raised fees for people who don't trade much at all. Schwab will charge $15 a quarter, or $20 for its Schwab One account. To avoid those fees, Schwab clients will have to raise their account balance above $20,000, or trade more than four times a year, or add $250 a month to their account.
That announcement came at the same time, but with much less fanfare, aimed at pleasing analysts who didn't want to see Schwab lose revenue by cutting fees. In fact, some analysts think the company will make much more by penalizing low-end customers and rewarding the most active.
"We have millions of these customers who are reasonably demanding of services, which we're pleased to provide but which have to be paid for," said Schwab President and co-CEO David Pottruck. "Customers have the opportunity to justify their service levels by adding to their account."
Majority of investors don't trade that much
Only one in six online investors falls into the most-active trading category, which Clemmer called the "get rich quick" group. They account for only one in 33 investors overall. But they're very geared to trading online, with 60 percent of them using the Internet to do their research, compared with 24 percent for all investors.
Now is the time that online brokerages need to appeal to a broader range of people, Clemmer said. Over the next two years, the wave of "aggressive affluent" investors will go online -- mainly middle-aged, well-educated professionals with high net worth and income. Like Walker, they focus on price and execution in picking a broker. Clemmer believes that to build proper relationships with them, brokerages will need to offer more advice and better services, because the market is already flooded with cheap trades.
The brokerages that Clemmer and others believe will win in the long term are the ones that attract the "portfolio cruise control" group, who don't trade often but want the convenience of having their accounts all in one place. Those people don't really trade online now, but by 2002 they'll account for the majority of online investors, Forrester predicted. More than any other kind of investors, they value advice and want their brokerage to guide their investment decisions, even online.
As the online-brokerage market develops, the brokerages have really split into three groups.
At the cut-rate end of the spectrum, serving the "get rich quick" group, brokerages such as Ameritrade, Suretrade and Datek still compete predominantly on price. But the ranks of the no-frills, "price first" brokerages will dwindle to a handful, most analysts think. By the end of this year, they will hit a wall, Clemmer said. "There just aren't enough of those people to go around."
The winning brokers will offer advice and execution
There's a growing number of brokerages searching for the middle ground, the "aggressive affluent" and the "portfolio cruise control" groups. At the high end of the market, there are brokerages such as Merrill Lynch, Morgan Stanley Dean Witter and Paine Webber, which command higher prices for their services but provide a lot of advice. With a wrap-fee account, they also often tie their online brokerage in with traditional offline brokerage services.
They're particularly well positioned to appeal to the advice-hungry "portfolio cruise control" investors, Clemmer said. But they stand to lose out if they confuse customers by muddling fees and commissions and if cheaper brokerages come up with ways of providing similar advice online.
Analysts say National Discount Brokers has a very full Web site from the standpoint of education, research and tools, for instance, without charging high fees.
That's the kind of service Walker is looking for. He can trade for $12 a pop at Waterhouse, which also offers him free Standard and Poor's and Zacks research.
Though full-service brokerages tout their proprietary research, Walker doesn't think he needs it. In fact he actively dislikes it. "I don't care a fig for any of the main-line brokerages. Their research is never any good -- they just have you buying stuff they are promoting," he said.
Jim Marks, online-brokerage analyst with CS First Boston, said that problem is a common one with full-service brokerages, which tout their in-house research but don't provide anything a customer can't get from another source like a discount broker. "Just because it's proprietary doesn't mean people pay more attention to it," Marks said.
At the moment, many investors split their accounts between different institutions, with part of their portfolio online and most of it in a conventional brokerage account. It's reasonable to assume that online brokers will follow Schwab's lead in raising fees and account minimums at the low end -- in essence, prompting customers to consolidate their accounts online.
"They're definitely trying to drive up their assets per customer," Marks said. "I don't believe they can make money on the person with $4,000 in mutual funds."
Analysts believe the real winners in the online brokerage battle won't go for the no-frills, cut-rate approach that makes investors feel they're on their own. They'll have to expand away from fickle active investors, who show little loyalty to their brokerage. They'll be the brokerages that, in Clemmer's words, create "mildly self-directed investors, who feel comfortable making most decisions but need a little handholding here and there."
Cheap frills keep investors like Walker happy
That describes Walker. Not that going online has been perfect. He's bothered that it takes too long to reach the brokerage by phone -- seven minutes last time he called, according to his timing. Every now and then he gets the "blue screen of death" when his computer locks up.
But he's happier online and wouldn't go back. He likes the cheap trades and the immediate response he gets. And he loves the cheap frills: the free research, free real-time quotes, and knowing there's a Waterhouse office in downtown Norfolk for him to visit if he needs to do so.
The brokerages just have to convince more "regular" investors to make the move Walker made two years ago. "I guess I was one of the pioneers," he said. "It was the right thing to do." 
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