“Should I Trust My Broker?”

From the Mailbag:

Love Wealthy Retirement and Marc’s dividend Safety Net. I have a question about stockbrokers. I’m in my late 30s and have been investing for about five years. Last year, I decided to get a broker to start making some trades for me.

I like the guy. He’s made me some money. But the problem is he always seems to call me toward the end of the month to recommend a new investment product or trade. And I’ve noticed that the fees with some of the products seem to be higher than some he recommends at other times. Do you think he has my best interests at heart? Should I trust my broker?

Short answer: I wouldn’t, and I was a licensed broker for nearly a decade. But there’s a lot more to that statement.

Brokers Are Salespeople

Would you trust the car salesmen on a used car lot? No.

[ad#Google Adsense 336×280-IA]That’s because you know they are trying to sell you something so they can put your money in their pockets.

Car salesmen don’t need to care about what they sell as long as they sell something.

The bigger and more expensive the sale, the more money they make. Brokers are compensated in the same way.

Remember, their job is not to manage your money or even give you investment advice. Their job is to sell you financial products. Period.

Just like in the case of a used car salesman, the more expensive the product, the higher their paychecks.

Stockbrokers make money by charging you a commission on every product you buy and sell. In most cases, brokers “double dip,” charging you on the way in (when you buy) and the way out (when you sell). It doesn’t matter if you made or lost money on the investment. The broker still gets paid.

Trust: A Broker’s Secret Weapon

Brokers will say or do anything to gain your faith, and I have heard it all. While working as an analyst at a small broker-dealer on Wall Street, I cringed every time I had to walk through the “pit.” The pit is where the young junior brokers sat in the open, cold-calling investors, hoping to open a new account.

I can attest that most of the lines from the movie Boiler Room are still alive and well, but there are a few new ones. My favorite, “I’m not allowed to make guarantees, but if I could…” will probably wind up in the next movie chronicling Wall Street’s excesses.

Regardless of the line, the intent is always the same.

Brokers are trying to convince you to trust them so they can earn commissions from your investments. The more you trust your broker, the more financial products you will buy from them. That’s how it works. Don’t do it.

Fiduciary Duty Versus Suitability

Some investors prefer to park their money with registered investment advisors because they have a fiduciary duty to you and your money.

A fiduciary duty means that when they give you advice on which investment products to purchase, they must put your financial interests ahead of their own. If a registered investment advisor sells two products that meet your financial needs and objectives equally, they should recommend the investment with the lower fees.

That’s not the case with brokers. This means it is perfectly legal for your broker to advise you to buy financial products with higher fees that benefit them more than you. Brokers abide only by the “suitability standard.” The investment they recommend must be suitable for your investment profile and objectives, but that doesn’t mean it has to be the best investment for your situation.

Even with their fiduciary duty, I still would not blindly trust registered investment advisors.

Most registered investment advisors are also registered stockbrokers. If you have multiple accounts with them, they may act as one or both. And guess what? The brokerage firm they work for will most likely hold them to the lower standard.

Temptation Is Hard to Resist

Most brokers are not actually writing themselves checks from your account, but they are highly motivated to profit from it at the expense of your returns. They do it all the time, and more often than not, the broker knows what they are doing is wrong even though it’s not illegal. The temptation is just too great.

One night, I was having a beer with a broker friend of mine when he told me a sob story. Literally crying on my shoulder, he told me he had not generated a lot of commissions that month and didn’t know how he was going to put food on the table for his family. That wasn’t the reason he was crying, though. He was crying because of what he did next.

He put his needs before that of his client’s.

In order to create a quick commission check for himself, this broker sold a risky private placement to a new customer. There was no need for this client to buy the private placement. My friend knew that. If they had wanted to own the stock, the client could have paid a lower commission buying the stock in the open market. But the broker sold it to him anyways. It was perfectly legal. The broker received a hefty commission check at the expense of his client’s returns.

No Trust… Anywhere

The sad thing is financial services employees don’t trust the industry, their competitors or even themselves. A recent report by the University of Notre Dame and Labaton Sucharow LLP found that the financial crisis and implementation of Dodd-Frank has done nothing to improve Wall Street ethics.

If anything, they have gotten worse.

Researchers surveyed 1,200 investment bankers, investment managers and senior executives, and the findings were shocking.

They found that 47% of the folks surveyed believed it was likely their competitors engaged in unethical or illegal activity to get a leg up in the market. More than one-third of those surveyed earning $500,000 or more a year admitted to witnessing or knowing about wrongdoing in the workplace.

Twenty-seven percent of Wall Streeters said they believe their compensation and bonus plans could compromise ethics or even violate laws, and a quarter said they would use nonpublic information to make $10 million if they were guaranteed not to get caught.

The worst finding of all is that 27% said they think the financial industry does not put the needs of its clients first.

The “Detective Rule” Solution

So what should you do? Fire your broker? Go it alone? Not necessarily, but you must always be on guard. We’ve said it before: No one cares about your money more than you. It’s your responsibility to ensure you aren’t paying excessive fees. As the account holder, it’s your job to monitor your brokerage statements for unusual activity or excessive fees.

When dealing with someone making money off your financial transactions, it is always best to follow the “Detective Rule.” It is quite simple: If you find yourself playing detective with your broker, it’s best to move your money elsewhere.

Trust your gut – it’s better to be safe than sorry.

Good investing,



Source: Wealthy Retirement