Should you trust your broker? No, and here’s why
- September 8, 2010
- 14 comments
- Posted in Investing, Latest Posts
I recently had an affectionate email from Steve, one of the devoted readers of this blog. I had written about the brokerage industry’s habit of giving investment advice while dodging the fiduciary rule – that is, the rule that advisers have to disclose all fees upfront and put their client’s interests ahead of their own. Because stockbrokers don’t want to take that step, I reminded readers not to trust them. Here’s Steve’s love note, in full but corrected for family reading:
Jane you say we (I am a RR) can’t be trusted. I am collecting statements like yours…expect to have you a** sued. I can’t believe you are saying s*** like this. You need to be very careful what you say. I am Series 7 et al and it is legal for me to sell securities. By the way I charge FULL commission, always, you GD idiot!
Hmmm. I’m glad I’m not a customer of his, especially because of that “full commission” bit. He doesn’t sound like someone who would cut a client a break.
Steve’s behavior and language is certainly not typical of people in his industry, who usually disagree politely and with reasoned argument. What is representative, however, is his angry demand to be trusted – full commission and all. It made me think that I should explain myself further.
To get customers, brokers have to sell the belief that you can trust them with your money. That belief is their primary product. If you have faith, you will buy the financial products they recommend. The same is true of financial advisers and financial consultants, if those are the titles that your broker uses, as well as financial planners and insurance agents who sell products on commission.
As a customer, however, you should never trust your broker, and I don’t mean that personally. You can like your broker, think him smart, or find him helpful. You can ask her for stock research or ideas. But trust should have nothing to do with your relationship. If it does, you’ll be on the losing side.
You and your broker (or financial consultant or insurance agent) have different interests. They have to sell things to make a living. The more they sell, and the more expensive the products, the better off they’ll be. Like any other salesperson – for shoes, cameras, advertising or high-tech medical devices – moving products is their job. Your job, as a customer, is to look skeptically at those products, ask yourself if you need them, compare them with other options and consider the cost. The more you pay, the worse your investments will perform.
All too often, investors get trapped by their brokers, emotionally. Because you’ve trusted and admired them, because you’re friends, you’re reluctant to think that something might be wrong. You don’t want to hurt their feelings by challenging their performance or making complaints. It becomes hard to move your account, especially if you’ll still see the broker in your social group.
Rule One for investors, then, is to keep their distance from their brokers. Don’t play golf with them or invite them to parties. This should be purely a business relationship. If you’re not satisfied, move on. Don’t open an account with a relative or the spouse of your best friend, who would be especially hard to shed.
Rule Two is to remember how little “trust” really means when the chips are down. Your broker wants you to treat his or her ideas as gospel. If it turns out that you were sold a pig in a poke, however, the broker will argue that the decision to buy was entirely up to you. If you trusted him, that’s your problem. So sorry. Bye bye.
Rule three is to understand the real nature of brokers’ jobs. They’re expected to bring in tens of thousands of revenue dollars each day. The firm “chains you to your desk in the morning and they’re not going to release you until a certain quota has been reached,” one broker said in a focus group for the National Endowment for Financial Education in Denver. When a broker asks a colleague, “How are you doing?” he’s not asking, “have your recommendations made money for your clients?” All he wants to know is, “How much have you sold and what commissions or other revenues have you racked up?”
Brokers take the heat when they push investors into expensive or mediocre products, but remember that management lights the fire. Even a well-meaning broker can be driven to rogue practices by a firm that demands high sales at any cost. New brokers and less successful brokers are especially vulnerable to this kind of pressure. If they don’t meet their quotas, they’ll lose their jobs.
It’s common for management to:
1. Offer incentives, such as higher pay or status vacations, for selling mediocre products that the firm makes extra money on. Some brokers love the game, others hate what this does to their clients but sell the stuff anyway.
2. Raise quotas to the point where brokers are tempted to churn accounts.
3. Order brokers to sell a crummy block of shares that savvier institutional customers have rejected.
4. Create a climate of callousness, by passing out perks and vice presidencies to big producers no matter how unsavory their techniques.
5. Mislead brokers about the riskiness of a financial product. For example, remember auction rate securities? They were supposed to be as safe as money market mutual funds while paying higher rates. When the market started to fail in 2008, some big firms hid the truth from their brokers and, in fact, pushed them to sell more.
6. Demand that brokers sell fee-based advisory accounts, even to clients who might not benefit. I recently asked a broker what her most lucrative product was. She responded, enthusiastically, “The big $ comes from fee-based accounts. We get that annually! Got to build the fee-based book of business to reap the real rewards!!!”
So as I was saying, don’t trust your brokers. Talk to them, learn from them, but suspect and investigate everything (for information, the Web is a big help). When it comes to expensive financial products, “no” is a mind-clearing, money-saving word.
Tags: financial advisers, financial consultants, stockbrokers
I feel fortunate that I read Investing for Dummies before I started investing outside my 401(k). Vanguard all the way :)
Great article – right on point!
What a perfectly timed blog! I just had some dealings with my broker that caused me to lose a little sleep. These are mild compared with the master of the English language you published, but it’s clear to me that, as you put it, he doesn’t have a fiduciary interest. Usually I talk to him about bonds (risky enough nowadays), but he invariably steers me to stocks in which he has “inside information”, which is usually yesterday’s news.
Don’t walk… RUN away from a broker peddling inside tips.
Ms Quinn: You make excellent points on why not trust our brokers. Let me ask, should we trust our soc. security rep? I went in last week to ask, when I retire, if I delay collecting my own soc. sec. for a added year , would it help improve my wifes eventual income, as well as my own income? ( hers in immediate term or long term assuming I am first to pass away..) She was not clear to me, but she seemed to say your wife took soc. security early, at age 62 , so even on when she draws your soc. sec. she will still face taking a reduced amount of your soc. security, as she took it early herself when she started, while you the husband did not. You are full age now, waiting until age 67 for sure, and perhaps holding off until age 68 you say.
But seems to me if My income is any higher than twice her present income, when I do take soc. sec. , she can elect to take one half my amount, if its more than her early age 62 soc. security benefit. Further, when I pass away, I thought she got to pick my level of soc. security benefit, not her own. By the time I pass, can she draw an income on my soc. security account based upon her age at time she taps into my account, or is it punished or set back to age 62 benefit, due to her taking her own soc. sec. benefit at age 62? Its a bit confusing. jim h. thanks. 9-12-2010
If your wife retires early, on her own Social Security account, she can make a later claim for a spousal benefit on your account, when you retire. Her spousal benefit will be reduced, depending on her age when she retired. On the plus side, she will have had several years of income that she’d have skipped, if she waiting for you to retire. If you die, she is not set back to her income level at 62. She can still claim her spousal benefit on your account, but it will be slightly reduced. A Social Security rep should be able to tell you what percentage of the full spousal benefit she’ll be able to take.
Just curious if these representations from my advisors are accurate.
My investments are with a well known non profit financial services firm that has been around for generations. They claim that based upon the risk profile I select (ranging from ultra conservative to highly aggressive), that the recommended allocation of my investable assets would be the same no matter which advisor I get at the company. They depend totally on their computer generated models for asset allocation advice.
Seems reasonable but can you confirm?
Please share your view…
Yes, that’s the way they’d do it. Quality control, to prevent an adviser from going off the reservation. the questions would be, did you choose the right risk profile in the first place?
Yes, that’s the way many large advisory organizations work. If it’s online at a no-load group, this is the most efficient. If it’s with a commissioned broker or planner, it’s a way of keeping them on the reservation and advising investments the firm doesn’t want its advisers to sell).
I selected the risk profile. I am comfortable with the risk profile I selected. Plenty of advisors would argue (and perhaps correctly) that I might be more conservative than necessary. I’m comfortable with my choice.
Ms. Quinn: My first visit to your website, and a toast to you. My former F/A at a now defunct brokerage firm, called one day with the advice that I should sell a home center stock in which we had a tidy profit “because it was about to drop in value.” I authorized the sale (which my husband was none to pleased about). The stock did NOT drop in value; in fact, it rose. About three weeks later, our local reported that my broker had been promoted to a vice-presidency. What did drop was his credibility. We now use an on-line brokerage firm. I can live with my own investing mistakes, but damned if I can live with his!
Great post – but I strongly disagree with the woman in point 6 bragging that annual fees are the ‘real rewards’ and think that was simply an attempt to paint fees in a bad light. Dig into the small print on the types of investments commission paid advisors are paid to sell to find ‘real rewards’ – which can be ridiculously large because investors have no idea what they are (and aren’t trailing commissions annual?!!). Commissions create a massive inherent conflict of interest – fees don’t.
I’ve had a hard time converting from managed mutual funds in a non-retirement brokerage account to index funds. The managed funds are proprietary and cannot be transferred, so I either have to liquidate them and pay capital gains taxes or live with the higher fees and turnovers. What would you suggest?
Thank you for sending this question. It’s a cautionary tale about buying a brokerage firm’s proprietary products. They effectively lock you in.
If performance is poor (as it probably is, with high fees and turnovers), the question is: would you rather pay the capital gains tax and get out, hoping to recover the amount of the tax in better performance from low-cost fund? Or stay where you and pay in poor performance. I can’t answer that for you. One consideration is how large a cap gains tax you’d pay and how old you are.