What To Know About Working With a Stockbroker
Jay Abolofia, PhD, CFP® is a fee-only, fiduciary & independent financial planner in Waltham, MA serving clients in Greater Boston, New England & throughout the country. Lyon Financial Planning provides advice-only comprehensive financial planning for a flat fee to help clients in all financial situations.
In his book The Four Pillars of Investing, financial theorist and author William Bernstein puts it bluntly:
“Under no circumstances should you have anything to do with a full-service brokerage firm . . . Severing that professional relationship is necessary to your financial survival.”
This is often easier said than done, as your broker may be your neighbor, friend or even family. In what follows, I shed light on the conflicts of interest and excessive fees that are commonplace in the brokerage industry today. (Please proceed with caution. What I’m about to share may shock you.)
Your Broker is Not Your Buddy
A stockbroker is a person in the business of buying and selling financial securities on behalf of customers. Long story short, a stockbroker is a professional salesperson. Brokers need trades to make money. Unlike investment advisors, who must register with the SEC or state securities regulator, brokers are not fiduciaries. Rather than being required by law to act in their clients’ best interest (like doctors, lawyers, bankers and accountants), brokers are instead subject to a “suitability” standard upheld by a private-sector organization. This standard says that brokers should “have a reasonable basis to believe a recommended transaction or investment strategy is suitable for the customer.” Yes, you read that correctly! As the old adage goes, a broker’s job is to slowly transfer his client’s assets to his own name.
There are no educational requirements to be a broker. No courses in finance, economics or law. Not even a high-school diploma. Earn a 72% on the simple multiple choice Series 7 exam and you’re ready to manage other peoples’ life savings. Spend five minutes reading my Four Steps to Successful Long-term Investing and you’ll know far more than the average broker.
Brokers have one incentive, and that is to earn their commission. This creates a minefield of conflicts. In their so-called Important Account Information booklet, a disclosure document hidden deeply within their website, Morgan Stanley beautifully summarizes many of these conflicts of interest. I count over twenty major conflicts (see pages 7-12). These read like a coup de grâce. Here are five I find particularly egregious.
“A Financial Advisor has an incentive to recommend more transactions or to break transactions into smaller increments that might generate higher and more frequent commissions.”
“A Financial Advisor has an incentive to recommend that you add more assets to your account, as it will generate a higher asset-based fee . . . [and earn them more] compensation based on certain milestones.”
“Financial Advisors may receive more or less compensation if, for example, clients select certain products over others.”
“Financial Advisors, could engage in outside business activities and investments or have outside or pre-existing relationships with product or service providers that conflict with their job responsibilities."
"Financial Advisors are also compensated when their clients borrow funds."
In short, you can’t trust much of anything your broker says. It’s not because they are inherently bad. It’s because they are trained and incentivized to sell, not to deliver objective advice.
Your Broker Charges Exorbitant Asset-Based Fees
Brokers are typically paid an investment management fee based on the amount of assets they manage in your accounts. These are called asset-based or assets under management (AUM) fees. For example, a 2% AUM fee means you’ll pay $20K in fees this year on a $1M account. As the account grows, the fee grows proportionately. These fees may or may not include any financial planning your broker provides and may be in addition to other fees, commissions, fund expenses, taxes, and investment-related costs. For example, brokers almost always recommend more expensive actively managed funds, rather than low cost index funds, even though indexing outperforms active management year after year.
Below is a summary of AUM fees charged by some of the largest brokerage firms for their most common investment management service for retail customers. Morgan Stanley, Ameriprise and Wells Fargo take the cake for highest fees. Although publicly available, this information is a bear to uncover.[1] These fees are typically assessed on at least the first $1-5M in the account, depending on the broker and service, with slightly lower fees assessed on higher account balances.
Two percent might not sound like much, until you consider that it’s ¼ to ½ of the gross annual return you may expect to earn in your accounts. Over years of investing, this can add up to hundreds of thousands of dollars lost, both to fees and lost investment growth—every dollar paid in fees is one less dollar earning compound interest in your account. With a 2% AUM fee, a $1M account growing at 6% a year will result in cumulative fees over 20 years of $623K and $443K in lost investment growth. This amounts to a loss of over $1M, or 48% of the account’s cumulative growth!
Break Up With Your Broker
Given these major conflicts of interest and exorbitant asset-based fees, Bernstein’s advice to break up with your broker really adds up. You’ll likely get much better financial advice and save hundreds of thousands of dollars by working with an independent, fee-only fiduciary. One with solid credentials and experience, who provides comprehensive financial planning, not just investment advice or management. Better yet, find an advisor who does all of this for a straightforward fixed-fee and your future self will thank you!
Here’s a video where I explain how paying a fixed-fee can save you hundreds of thousands of dollars
Footnotes
[1] Fee information can often be found in the firm’s disclosure documents. For example, read the section on “fees and compensation” in the firm’s “wrap fee” program brochure or ADV Part 2A. Here are source links I used for each firm: Morgan Stanley, Ameriprise, Wells Fargo, Merrill Lynch, Edward Jones, UBS, Fidelity, Charles Schwab.