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9 Things Brokers Won't Tell You

In tumultuous times like these, working with a trusted broker can be a source of comfort and peace of mind. But as The Atlantic's Jeffrey Goldberg writes in the magazine's May issue, that peace of mind might be misplaced. The relationship you think is based on trust might instead suffer from conflicting interests.

Let me say at the outset that this story isn't meant to denigrate all brokers; many are able to overcome conflicts of interest and provide prudent, reasonable advice. However, that's not always the path to success for a financial adviser. More than 11,000 have left their jobs in 2009, many of them fired for failing to produce enough revenue to suit their bosses. (At that pace, The Wall Street Journal forecasts, nearly 35,000 brokers will close up shop this year, leaving about 630,000.) And where are the brokers supposed to get that revenue? Author and adviser Bill Bernstein provides the answer relating the (perhaps apocryphal) boast of a senior broker: "Over the years I've gradually transferred the assets of my clients to my own name."

To retain (and grow) your assets, watch out for these nine things your broker just might not tell you:


1. My recommendations might be based on how much I get paid, since I don’t have a fiduciary responsibility to you.

A fiduciary must put your interests ahead of his own. But most brokers are held to a “suitability standard,” which means they can make recommendations based on factors other than what’s best for you — namely, efficiently priced investments that match the level of risk you’re willing to take. Instead, they can push investments that happen to be best for them or their firms. For instance, it’s hard to make a case for owning a variable annuity inside an IRA. These annuities are typically expensive (annual fees of 2 percent are not uncommon), and their primary benefit — tax-deferred growth — is already available within the IRA. Putting a variable annuity in an IRA is like putting an extra set of shingles on your house. Yet many brokers sell annuities this way because they’re well-compensated for doing so.

2. I’m unlikely to tell you all the fees you’ll pay.

Your broker might put you into a wrap account — one that can own a variety of mutual funds and other investments — pointing out the brokerage account’s 1 percent or so annual fee. He might not mention that you’ll also pay other hidden fees, such as the expense ratios and transaction costs of the funds inside the account. These expenses can easily double your cost.

3. I might not be as knowledgeable as you think.

A broker is a salesperson, plain and simple. The job doesn’t have an education requirement (other than passing a licensing exam from the National Association of Securities Dealers and, often, state exams). It doesn’t require that the broker demonstrate any investment expertise. If you get the feeling that you have a better understanding of investment concepts than your broker does, you’re probably right.

4. I’m a performance chaser.

Brokers like to sell what’s hot for a simple reason: It’s easy. In 1999, it was tech funds. In 2006, real estate investment trusts. In 2007, emerging market funds. In 2008, well, not much was hot. Count on your broker pitching you an investment in the hot sector of the moment, just in time to buy at the top.

5. My definition of “diversified” might be kooky.

To illustrate this point, it’s hard to beat the story MoneyWatch’s Allan Roth recounts in his book, How a Second Grader Beats Wall Street. Roth, who runs an investment advisory firm, was approached by a woman with a broker-run retirement account that held a number of pricey mutual funds. Roth suggested she replace the funds with two less expensive exchange-traded funds (ETFs), essentially index funds that track a market. One owned a replica of the U.S. stock market and one tracked international stocks. She’d pay her broker 0.5 percent per year for his trouble. Her broker agreed to the arrangement, and everything seemed fine until six months later, when he called Roth in a panic. His firm’s compliance department had flagged her account as insufficiently diversified because it owned only two securities; the brokerage required three. By this firm’s incomprehensible standards, three microcap stocks provided a more diversified portfolio than two ETFs that owned essentially every publicly traded company in the developed world.

6. I have a quota.

It might be in your best interest to buy and hold for the long term, but this approach isn’t in your broker’s (or his firm’s) best interest, since it doesn’t generate many commissions. The broker’s quota might take the form of subtle encouragement to push certain proprietary financial products, as dozens of former Fidelity brokers now allege. That kind of system is often enough to keep a broker employed. After all, how long do you think he’d last if he recommended you buy and hold while the broker in the next cubicle was furiously moving his clients’ money around and generating commissions left and right? So when your broker calls suggesting you sell this and buy that, ask him why. Don’t agree to the trade until you’re convinced the reasoning is sound.

7. You can’t sue me.

Most brokerage firms are members of the Financial Industry Regulatory Authority (FINRA), their self-regulatory agency. When you open a brokerage account, you sign away your right to take the firm to court, agreeing that any disputes will be settled through a FINRA-run arbitration process. Surprise, surprise: It’s notoriously difficult for investors to emerge victorious in a brokerage arbitration. Last year, customers won damages in just 42 percent of FINRA arbitration cases. And those figures include investors who won any amount, regardless of how much they were seeking. Investment adviser and Huffington Post blogger Dan Solin found that in 2004 the average investor recovered just 22 percent of his claim.

8. Those letters after my name may not mean much.

Many of the alphabet-soup designations that brokers tout have one thing in common: They are designed to lend a hint of authority but don’t require much more than the ability to fog a mirror and write a check for the privilege of using them. Lately titles with the word “senior” — Certified Senior Advisor (CSA) and Certified Senior Consultant (CSC), for instance — have come under a great deal of scrutiny. Many state regulators view them as simply marketing tools to convince senior citizens that they’re working with an expert.

Some designations are legit, such as Certified Financial Planner (CFP), Chartered Financial Analyst (CFA), Chartered Financial Consultant (ChFC), and Chartered Life Underwriter (CLU). Of course, using an adviser with one of these designations doesn’t guarantee you’ve found a virtuous consultant. It just means the broker has completed a demanding curriculum and should have a basic core competency.

9. My clean background might not be so clean.

FINRA encourages customers to vet potential brokers with the BrokerCheck feature on its Web site, which lets you see if a broker has been subject to any disciplinary action. Until recently, however, FINRA let brokers negotiate the removal of claims from their records. FINRA’s new rules make this more difficult to do going forward, but they leave years worth of expunged complaints undisclosed. Additionally, as Forbes notes in a recent profile of one shady broker, the brokerage firm might “simply choose not to disclose customer complaints or the real reason for a broker’s departure [from the firm], either to avoid sullying their own reputations or over fear of defamation suits.” Instead of relying solely on FINRA, dig a little deeper. Independent websites such as Investor’s Watchdog will, for a fee, provide you with a detailed history of your broker. The SEC’s site also has a helpful list of questions to ask any potential broker. In the end, remember that the relationship with your broker an be an adversarial one, based on conflicting interests; keep an eye on your interests, because you’re probably the only one who will.

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