Should I work with a broker?

Investment broker. Stockbroker. Financial advisor. These are all terms that have been used over the years to describe a specific kind of investment professional that is registered to sell securities. You can use any of these names, but their formal title is registered representative.

Registered representatives are different to fee-only investment advisers and financial planners. And since their job is to sell financial products, they’re more commonly called brokers.

Investment broker: A partially accurate description

Brokers are licensed by the Financial Industry Regulatory Authority (FINRA) to trade stocks and bonds on behalf of investors. They’re also registered to sell securities such as mutual funds, annuities, and other financial products. So, even though investment broker isn’t an industry recognized title, it is an accurate description of what they are salespeople.

What’s the difference between a broker and a stockbroker?

Absolutely nothing. In the days before online trading, you had to hire a registered representative to buy and sell stocks. These stockbrokers would make a commission on every trade, regardless if you made or lost money. But as mutual funds began to replace individual stocks as the investment of choice, brokers gradually began to spend most of their time selling mutual funds.

Where do brokers work?

All brokers work for brokerage firms. These are SEC-registered companies that enable investors to buy and sell securities. Discount brokerages like E-Trade, Fidelity and TD Ameritrade let you invest on your own using their online trading platforms. Full-service brokerage firms like Merrill Lynch, Morgan Stanley and Edward Jones use brokers to invest on their clients’ behalf.

What’s the difference between broker dealers and brokerage firms?

Brokerage firms are the client-facing divisions of broker dealers that buy and sell securities for their own accounts or their clients’ accounts. The dealer side of the business buys and sells the securities, sometimes directly from the issuers, and then makes them available for the broker side of the business to sell to investors. For example, acting as a dealer, the firm might purchase a million shares of Apple stock, and then use its brokers to sell these shares to clients.

How are brokers paid?

Unlike fiduciary investment advisers, brokers are not paid directly by clients. Instead, they’re paid commissions for making trades and for selling mutual funds or other products to clients. By law, brokers must state up front what these costs will be.

For example, a broker might charge 2% of the cost of a stock trade. So if you bought $10,000 worth of Apple stock you’d pay $200 in commissions.

 

Mutual fund commissions work differently. Some funds sold by brokers will carry a sales charge – often 5% or more of the amount you invest – that you pay when you purchase or sell shares. In addition, most broker-sold funds charge annual 12b-1 fees, a percentage of invested assets used solely to compensate brokers and their broker dealer firms.

For example, if you invested $10,000 in a mutual fund with a 5% up-front sales charge, $500 of that investment would immediately be deducted, leaving $9,500 as your net investment amount. If the fund charged a 0.15% 12b-1 fee, you’d pay an additional $142.50 from your account every year (of course, this amount will rise or fall depending on the value of your account).

What is a broker’s responsibility to you?

A broker is only required by law to recommend investment products that reflect your investment goals, risk tolerance and level of investment sophistication. This is known as the suitability standard. Once these conditions are met, the broker is allowed to recommend products that offer them the best commissions. Fee-only advisors, on the other hand, are required by law to serve as fiduciaries, meaning that they must always act in your best interests.

Is a broker right for you?

If you don’t want to pay an advisor directly to manage your entire portfolio, a broker might, in some cases, be a more cost-effective choice. But keep in mind that brokers are, essentially, salespeople. And like all salespeople, they’ll want to push solutions that offer them the best compensation.

Fortunately, as an investor, you have the right to ask them how much their commission-earning potential is affecting their actions, and, by law, they must disclose this information. Once you have the full story, it’s up to you to decide if you wish to accept the broker’s recommendation. If, on the other hand, you’d rather work with a financial advisor who has your best interests at heart, we can help you find one.