Hundreds of thousands of securities brokers provide essential services for investors. These services allow us to buy and sell stocks, bonds, mutual funds, ETFs and other types of financial instruments.
For two years in the 1960s I was a stock broker myself. Part of my job was to help investors with such trades.
Another part of my job was to generate commissions for the Wall Street firm that employed me. But being a broker today is not the same as it was at that time, and because it's not, investors should probably take another look at why they're using them.
In my time as one, brokers were not trained as financial advisers. Today's brokers are expected to give investment and other financial advice, as well as expedite trading. Some of them do a terrific job of doing that; unfortunately, others are still primarily focused on generating commissions.
As a result, I have to question whether employing a broker is the best use of my money. In fact, I don't think it is. And I don't think it's the best for others either.
I'm not alone in these views. I call your attention to a report from Senator Elizabeth Warren. Focusing on kickbacks and other conflicts of interest in the annuity industry, this report should be required reading for anybody considering buying an annuity. If you don't do anything else, read the brief executive summary for an overview.
You may have seen a recent news item regarding Citibank's agreement to pay $180 million to settle charges involving a couple of hedge funds. Citibank's brokers, eager to earn commissions, misrepresented the hedge funds in order to make sales.
I cite this instance, one among many that have occurred, to illustrate the biggest reason for my distrust of brokers. Brokers are heavily pressured and incentivized to do almost anything to make the sale.
Sometimes, this means blatantly misleading investors.
In the Citibank case, Citibank raised nearly $3 billion from roughly 4,000 investors who lost their shirts when these funds collapsed in 2008.
See the rate of interests in this wonderful products!
Maybe it's hard to feel terribly sorry for wealthy people who suffered along with the rest of us in 2008 because they didn't do their homework.
But the brokers who sold those funds pitched them as safe, low-risk alternatives to bonds. They did this even though the firm's marketing materials explicitly stated that these funds should not be used as bond substitutes.
If the brokers read that material and understood what it meant, then they must have been flat-out lying to clients. If the brokers had read that material and didn't understand what it meant — or if they had not read it at all — that sounds to me like gross incompetence.
Either way, there's no excuse for it.
An article at Investmentnews.com quotes the chief of the enforcement division of the Securities & Exchange Commission as saying: "Advisers at these Citigroup affiliates were supposed to be looking out for investors' best interests, but falsely assured them they were making safe investments even when the funds were on the brink of disaster."
And what did Citibank have to say for the record? A spokeswoman said the firm was "pleased to have resolved this matter." Clients lose billions of dollars because brokers misled them. Citibank is "pleased." And you wonder why I have a problem with brokers and their employers?
Here are some reasons I don't think investors should use brokers any more
1. Brokers minimize the risks you are taking.
Every investor should know and live by the sharp distinction between what's theoretically possible (You could win the $300 million lottery!) and what is probable (You'll have some paper tickets to add to your recycle bin).
But brokers often are unwilling to let minor details like that get in the way of making a sale — and a commission. Instead, a financially successful broker is likely to focus on the great possibilities of a company or a product or a manager, while minimizing any risk that might be involved.
2. Brokers misrepresent not only what they have for sale, but themselves as well. If some of them were brutally honest enough to tell clients they had little training or experience, they'd starve. It's not uncommon for brokers to state or imply that they have designations that they don't.
In response to a savvy client's question "Are you a fiduciary?" a broker may say or imply that the answer is yes. But try to get such a statement in writing, and you'll usually come up short.
3. Brokers must sell at all costs. Brokers are under intense pressure to sell the products their employers are obligated to foist on the investing public, whether or not those products are suitable or worthwhile for clients.
Sure, brokers would like their clients to make money and be successful. But that doesn't mean much to brokers' bosses: They don't know those clients and maybe won't ever see them. What the bosses care about is commissions. And no broker can stay in business for long without satisfying the boss.
4. The products that make the most money for brokers and their bosses are ones that pay the highest commission rates. Those are the products that are hardest to sell. They're hard to sell because they are especially risky and often complex.
The end result of that trail of reasoning is that brokers are strongly motivated to sell risky, complex things instead of relatively simple solutions with minimal commissions, such as index funds.
This point really boils down to three words: Conflict. Of. Interest.
5. The brokerage system dangles huge rewards in front of securities brokers. A very good independent (no commissions, no conflicts) investment adviser can make $250,000 a year after 10 years in the business.A hard-working broker operating on sales commissions can make four times that much after only one or two years in the business.
So far I've focused on securities brokers. Now let's return to insurance agents.
Lots of financial advisers sell securities under one set of licenses and sell insurance under other licenses. The walls between these activities are often blurred, and it's sometimes hard for any but the most persistent client to figure out what's really going on behind the scenes and the resulting incentives to recommend one product over another.
Securities brokers are required to disclose their compensation, even if it's buried in obscure fine print that investors rarely read. But insurance brokers have no such requirement. In addition to cash, their compensation can include office overhead, trips, vehicles and other perks.
Here's a hypothetical example that will give you a fairly accurate idea of how insurance salespeople are compensated.
Insurance agent George sells client Sally a whole life insurance policy that covers her for as long as she continues paying the $100 monthly premiums. The insurance company pays George what is known in the industry as a 90/5 commission. That means George gets 90% of her first year's premiums (or $1,080) and 5% of the subsequent premiums she pays.
As long as Sally keeps paying, he'll get $60 a year. If George can sell one or two such policies a week (not necessarily easy, but certainly possible), he can make $50,000 to $100,000 a year.
Eventually, after enough clients have bought such policies, the renewal premiums will add up to a nice steady income that requires very little work to maintain. (Here's the math: 100 policies a year for 10 years adds up to $60,000 a year.
A hard-working insurance agent certainly should be fairly compensated, and I have no problem with that. But I think it's unfair when insurance agents represent themselves as investment advisers working in the interests of clients while selling expensive, restrictive products such as index annuities.
If you're looking for an insurance product, your best bet is to shop at a low-cost vendor such as Vanguard. Instead of a broker whom you may or may not wish to trust, you'll deal with a sales representative who is not motivated by commissions. That's my idea of a deal worth doing.
Finally, whether or not you use a broker, I highly recommend my book "Get Smart or Get Screwed: How to Select the Best and Get the Most From Your Financial Advisor."
Richard Buck contributed to this article.
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