is virtually impossible forone analyst to specifically call a top or bottom in a sector (or the market overall).
A FIELD GUIDE TO BROKER IDENTIFICATIONThe new millennium brought with it several types of brokerage firms that fall intothe following categories:• Full-service brokers: Offering stocks, bonds, mutual funds, options, and investment advice.• Discount brokers: Offering stocks, bonds, mutual funds, and options without,or with very little, investment advice.• Deep-discount brokers: Offering stocks, bonds, mutual funds, options, and noadvice.• Online brokers: Offering stocks, bonds, mutual funds, options, with no advicebut various levels of electronic help files to help educate the investor.Let’s examine each category in depth.
Full-Service BrokersThe full-service brokerage firm is the most influential entity on Wall Street today.Sometimes referred to as “wire houses,” these venerable institutions have built vastdistribution networks of brokers in offices anywhere they think large sums ofmoney reside. Their brokers actively market ideas and strategies to their clients andprospective clients in an effort to win their trust, confidence, and most if not all oftheir investment capital. Companies such as Merrill Lynch, Paine Webber, SalomonSmith Barney, Morgan Stanley Dean Witter, Goldman Sachs, and Donaldson,Lufkin & Jenrette (DLJ) are almost household names these days.These firms do their level best to deliver accurate investment advice to their customers, and offer a dizzying array of financial products including checking ac-
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counts, money market accounts, their own mutual fund families, and of coursestocks, bonds, mutual funds, and advice aplenty. In some cases they’ve even invented their own indexes that keep track of particular market sectors.Money market account: A securities market that primarily deals in short-termdebt instruments that mature in less than one year and are very liquid. Thefund’s main objective is to earn interest while maintaining a stable net assetvalue of $1 per share.
The analysts hired by these “houses” are extremely bright and well-educated overachievers with heads for numbers and business models. They investigate companiesand generate investment reports that are disseminated regularly to their clients andbrokers. They even have “market analysts” whose recommendations have the abilityto move the financial markets with their public opinions. Some have been around along time, achieving almost mythical status. (Peter Lynch, the man who made theMagellan Fund so successful, is one such person.) Others labor in relative obscurity asthey research every aspect of a sector or company in an effort to give their clients atrading edge.But just because you’re on the phone with a top firm’s broker doesn’t necessarilyimply he or she is going to give good advice on any given day, much less on a consistent basis. Why? Because to become a broker you need only have a license—called a Series 7, which can be obtained after studying for a short period—and asomewhat pleasant demeanor that will appeal to total strangers.Most brokers are salespeople learning to become market gurus. A percentage ofthem eventually evolve into good brokers, able to dispense solid investment advicethat truly is in your best interest and capable of reading market conditions accurately. But it’s difficult to determine where the broker is in this curve, so great caremust be taken in the early stages of a relationship.Series 7: A specific license (General Securities Registered Representative License) issued by the National Association of Securities Dealers (NASD) that entitles the holder to sell all types of securities products, with the exception ofcommodities futures.
In many cases, these brokers are paid strictly on commission. This isn’t exactly asituation that prevents conflicts of interest, is it? To illustrate a point, let’s imagineit’s the end of the month, and the broker (whose paycheck comes once a month andis determined by “production,” or commissions generated) is having a poor month.Needing some sales in a hurry, he (or she) looks through his (or her) book for an account with idle cash to invest or stocks that can be sold to capture profits. Portfoliolaggards also get jettisoned at this point, the proceeds reinvested into the latest“great idea.” Some brokers use fear and greed to motivate a client to issue a “sell”or “buy” order. These brokers, fortunately, don’t last too long in the business, for
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Churning: Excessive trading in a customer’s account by a registered representative who ignores the customer’s interests and seeks only to increase commissions; this violates the NASD Rules of Fair Practice.Commission: A service charge assessed by a broker in return for arranging thepurchase or sale of a security. The amount of the commission varies dependingon whether it’s a fixed cost or a percentage charged on the transaction’s value.
they aren’t placing the clients’ interests ahead of their own. But the potential forneedless transactions or churning exists nonetheless.Full-service brokers also collect much higher commissions as a rule, and rightlyso. They are charged with “overseeing” portfolios for investors who are often toobusy making money to effectively be a watchdog over them. The full-service brokeralso provides timely research opinions and recommendations, as well as attractivesecurity offers such as a hot IPO.A word of caution: Just because someone is licensed to take an order doesn’tmean that individual has the knowledge to invest your money wisely.
With little effort a customer could unearth many stories of excessive trading(called churning) in an account—ill-timed recommendations either to buy or sell, andrecommendations that are not suitable for the investor. Suitability is of paramount importance when a broker recommends an investment. The potential customer should beasked to convey an accurate picture of his or her assets and investment expertise, aswell as goals and risk tolerance, before a recommendation is made. This is why somesecurities are termed widow and orphan investments, which is another way of indicating safety instead of high risk. A good, experienced broker is worth his or her weightin gold as well as every penny received in commissions. As a novice, it is your challenge to seek out a good broker. The best way to meet this challenge is by paying attention to what others are saying about their investment advisers.Widow and orphan stock: A safe stock that typically pays high dividends, offersa low beta coefficient, and is often associated with noncyclical businesses.
So how can you determine whether the person asking for a portion (or all) ofyour available investment dollars will truly be an advocate (consistently placingyour needs first) or a selfish rookie more concerned with production? Here are somequestions to ask:• How long has the broker been in the business?• What are his or her biggest positions and why?• What is the broker’s specialty? Where does the bulk of his or her commissiondollars come from? Some brokers specialize in government bonds while oth-
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ers fancy themselves to be stock pickers. Stick to the ones that most closely reflect your philosophy.• When a recommendation is made, what is the expected “hold time”? That is, howlong can you expect to have it in your portfolio? If a sudden move up occurs(which is always nice), will you be urged to capture the quick profit or will yourisk riding it back down, focusing more on the Big Picture of long-term growth?A real eye-opener is to contact the National Association of Securities Dealers(NASD), the governing body of brokerage firms. Inquire as to any disciplinary action or complaints against the broker in question. In addition, always ask in advancefor a sample monthly statement. Some firms have relatively easy ones to read, whileothers are more difficult to decipher than the Dead Sea Scrolls.If possible, ask for referrals. Nothing sells like word of mouth. While you’re atit, ask around! Who are your friends using? What do they think of the firm itself? Ifyou do this long enough, the same broker’s name will keep popping up. Be proactive and contact him or her to set an initial interview date.When you begin a relationship with a broker, by all means be patient. Many customers determine the future of their relationship based on the first trade or two.Market circumstances can unexpectedly move against both of you, and this shouldbe taken into consideration. But be wary if the broker’s first idea is not suitable foryou, or you just aren’t comfortable with it. This is a signal your risk tolerance or investment goals were either ignored or forgotten, and doesn’t bode well when you’reconsidering a long-term relationship.Another approach some brokers take is to suggest a strategy for buying a basketof stocks, or to ask you to deposit a lump sum that will be invested as conditionswarrant. In many ways this is a much fairer method of determining the value andexpertise of the broker. Ask the potential adviser, “How would you invest X amountof money in today’s market? Which stocks do you like, and at what price?” Trackthe recommendations closely using the newspaper or by going online. This is a riskfree method of broker evaluation.When Should You Change Brokers?Easy answers to bitter lessons:• Unauthorized trades in your account.• Consistently suggesting unsuitable recommendations.• Excessive use of margin, a sign of hunger for more trades in many cases.• Account activity (your commissions should add up to 1% to 2% of your portfolio value in a year’s time; if the total is much higher than that, a heart-toheart meeting with your broker is called for).• “He never calls, he never writes. . . .” Sometimes a broker will outgrow you(i.e., your account doesn’t warrant his or her increasingly valuable time). Youbecome ignored and are never contacted. Some people are fine with this. Ifyou’re not, ask to be referred to another broker who will commit the necessarytime to addressing your concerns and investment objectives.
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You’re Ultimately Responsible for EverythingThe client-investor owes it to himself or herself to learn the basics of investing,even if the advising broker is doing a superb job. Why? Because circumstanceschange, and one day you may just find yourself adrift, looking for a new broker. If aperson insists on staying ignorant of the basic mechanics of the market, the burdenof responsibility should be placed squarely on the client’s shoulders. At the veryleast, as with attorneys, the best time to find a broker is when you don’t need one.Have a contingency plan, just in case. This book is designed to give you the necessary tools so eventually you’ll be able to direct your own account.
Discount BrokersDiscount brokers offer access to the markets without all the advice a client would getfrom a full-service firm. Many experienced investors choose to do their own research,trusting themselves more than anyone else, and as a result pay less than a person doing business at a full-service firm. The discount broker is directed by the customer’sorders. The vast majority of the time they will defer offering specific opinions on astock, a bond, or the markets. Many times this is due to a policy the firm may impose,wishing to avoid liability. They provide real-time quotes, often have computers youmay use to check market conditions while in their offices, can assist you with the necessary documents for opening an IRA (individual retirement account) or transferring a401(k) plan, and can facilitate the purchase of no-load mutual funds.They charge less because they do less. The broker at a discount firm typicallywon’t create an investment strategy, but will suggest ideas when you describe whatyou’re after. They provide accurate, real-time price quotes, have access to the bondmarket, and even make mutual funds (both load and no-load) available to their clients.(Note: Some discount firms charge transaction fees for no-load mutual funds.)
Deep Discount BrokersDeep discount brokers offer extremely discounted rates on the buying and selling ofinvestment securities. The reduced trading commissions are available to individualinvestors and are sometimes more than 50% less than traditional full-service brokerage firms. An example of a deep-discount commission is $14.95 per trade for orders less than 5,000 shares. Trading costs will vary from one deep-discount brokerto another. In addition, the commissions will vary based on the type of order. Forexample, some brokerage firms allow investors to place a “market” order for free,or a minimal cost, but charge standard rates for “limit” orders.Many online brokerage firms are deep-discount brokers. The automated systemsassociated with web trading have reduced the broker’s cost of executing trades andthat, in turn, has led to a proliferation of deep-discount brokers on the Internet. Oneimportant element that distinguishes web-based and traditional full service firms isthe amount of advice available to investors. Online investors receive little to no in-
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vestment advice. As a result, online deep discount brokers have enabled a largenumber of do-it-yourself investors to trade securities independently of financialadvisers and stockbrokers.The deep discount broker has emerged as a force to be reckoned with on the Net,as technological advances such as ECNs and the Small Order Execution System(SOES), and new and better access to research information have come together toempower the retail investor.No longer does the “little guy” require guidance from the full-service brokers,nor does the self-motivated investor need to step into the local office of a nationalfirm to get his or her research information. They simply log onto the Net and, afterdownloading any number of research reports, or listening to live conference callswith analysts and market gurus, they can decide when to buy and sell, and do so atcosts once thought to be unrealistically low.Deep discount brokerage firms reduce their costs by relying on someone else toprovide research. Most times this information is free, but not always. They maketheir money the same way a bank does: They charge you interest when you borrow(on margin), they collect fees when they “lend” your stock to someone else so theymay short sell it. And there’s the usual transaction fees, the nickel and dime coststhat can infuriate you.Commissions are around $9.95 a trade, (for a market order), but do go up if youneed to speak with a broker or place a limit order. Some cater to the options trader,(Wall Street Access, www.wsaccess.com), Preferred Trade (www.preferredtrade.com), Datek Online, (www.datek.com); Ameritrade (www.ameritrade.com); E-Trade(www.etrade.com/cgi-bin/gx.cgi/applogic+Home); SureTrade (www.suretrade.com),and T.D. Waterhouse (www.tdwaterhouse.com/index.asp), National Discount Brokers(www.ndb.com), Mr. Stock (www.mrstock.com) are just some of the firms competingfor your investment dollars. As always, read the fine print. Option trades are NOT thesame price as stock trades. They usually involve a flat fee plus a charge per contract.The list of DDBs (deep discount brokers) is extensive. A few web sites keep upto date listings, and even review them. TheStreet.com has a section that does this(www.thestreet.com/funds/personalfinance/908807.html).
Online BrokersBoth discount and full-service brokers have taken to the Internet the way a ducktakes to water, and why shouldn’t they? The Internet has provided the ideal platform to transact business, and investors have followed them right into the pond. Asof this writing there are currently more than one hundred online brokerage firms tochoose from. The waters get very murky here for they are all vying for your business, and to get it, some have spent considerable sums for marketing and the building of extremely high-tech infrastructures. These costs are no doubt recouped fromthe increased assets under their control and burgeoning commissions. Familiarnames such as Charles Schwab have been able to grow considerably, due in largepart to the sharp increase in the quality and quantity of research brought about by
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the Net and the huge surge in computer usage. No longer do the wire houses havean edge in the research department, or even the inside track to the trading floor.Choosing an online broker comes with a variety of unique questions and issues.Not only do you have to make sure that your broker provides excellent order executions, but you need to investigate its track record when it comes to server breakdowns, and how successful its contingency plans have been during a loss of onlineservice. Currently, battle lines have been drawn in the online arena as full-servicebrokers go toe-to-toe with discounters. Although the resources of the Internet levelthe playing field a bit, it’s very important to know just what you should be lookingfor when you go surfing for an online broker.Today just about every brokerage firm offers online trading, but not all of themoffer the same services. Choose carefully—commissions vary widely as well.
RESEARCHAs indicated before, full-service firms lead the way in offering research, and lots ofit. Some firms have great research, while others seem lacking. Generally speaking,if you are a client of these firms you receive their research material gratis, eitherelectronically or by snail mail. The nature of being online means the client is able toreceive up-to-the-minute research without waiting for the mail, can access dailymarket commentary, and recently has gained the ability to participate in “chats”with analysts and company executives.Discount brokers have utilized the incredible power of the Internet to deliver research to you as well—the cost of which varies. Most firms offer freebies such aslinks to news sites, plus real-time or delayed quotes (delaying quotes is more afunction of the stock exchange than the broker). As usual, performance equals cost,so 20-minute delays are the norm unless, of course, you’re willing to pay. There aresome firms, however, that offer real-time quotes as part of their service, which isnice but not absolutely necessary in most cases. Of all online investors, not everyone requires real-time quotes. Active traders certainly need it, but many timesthey’ll be subscribing to quote services that cater directly to traders.Delayed quotes: Quotes that are delayed up to 20 minutes from the actual pricechanges at the exchanges. Delaying the quotes is more a function of the stockexchange than the broker; as usual, performance equals cost, so 20-minute delays are the norm unless, of course, you’re willing to pay.Real-time quotes: Streaming quotes that are received as the prices change at theexchanges.
As mentioned earlier, research on stocks is updated and disseminated almost immediately these days. There is an abundance of research sites that offer tremendous
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amounts of information. Balance sheets, pertinent financial information, and brokerage estimates are all assembled for you to review, most at no cost. Even the companies you’re interested in have begun providing profiles online, which can beextremely helpful to novice and expert alike. However, it’s very easy to get information overload or analysis paralysis, as I like to call it. Knowing what kind of information you need prior to searching is a prerequisite. Market analysts andprognosticators of the market in general are especially prone to sending out conflicting signals, and can make you hesitate, unsure of whom to believe. Spend a little time beforehand evaluating your own needs and wants. The person that seeks his(or her) own counsel will require more information than the person with a mutualfund or two looking to check the NAV (net asset value) once a week.To be sure, the major brokerage firms will allow a prospect to get a taste of their research as an enticement. Quality information, however, either low-cost or free, is easyto come by on the Internet, so the weighting of research in the decision as to whichbrokerage firm to sign with is lessened. I prefer to concentrate on how easy the information is to get and apply, and how easy (or difficult) it is actually to place a trade.
COSTSIt’s difficult to make it through a day without hearing about “eight-dollar trades” or“lower margin rates.” The competition is keen to capture the active investor as wellas gather assets. The gathering of assets is critical because in-house assets provide agreater potential for income to the brokerage firm just as they do for a bank. But beware whenever you hear of low-cost transactions, because the fine print may indicate otherwise in many cases.Low-cost transactions most often apply to the easiest orders to execute—marketorders—because they do not require much effort from the broker. More complicatedorders often require a higher, nonadvertised commission price. The low advertisedprice gets you in the door, but read the fine print before placing a trade! Here’s a listof items that can help you get a clear and concise picture of any brokerage firm.
Market order: Buying or selling securities at the price given at the time the orderreaches the market. A market order is to be executed immediately at the bestavailable price, and is the only order that guarantees execution.
What Services Does the Brokerage Firm Offer and at What Cost?• Does the firm offer stock charts? Are they easy to use? What information dothey provide?• What is the interest charged to use margin? (This term refers to borrowingmoney from the broker, using your stock as collateral. You may either buystock or actually take cash from the account.)
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A WORD ABOUT COMPLAINTSIt’s an unfortunate part of this business, but there are times when you’ll be less thanhappy with your broker, for any number of reasons. If the source of your unhappinesspersists, stronger measures are called for. A written complaint to a broker-dealer reallyshakes things up. Letters are serious, regardless of the tone or intention behind them. Ifyou’re not getting the results you expected from a broker or brokerage firm, a letter tothe branch manager and/or broker usually clarifies or rectifies any misunderstandingsfairly fast. If this doesn’t remedy your dissatisfaction, contacting the NASD (NationalAssociation of Securities Dealers), the governing body that oversees the brokeragecommunity, is the next step. No broker wants a call from these people for any reason.If your account has had unauthorized trades (trades executed without your consent), overtrading (affectionately known as churning), or some other nuance thatyou don’t fully understand, don’t be shy. Confront your broker. Face-to-face meetings are best, but don’t let anyone bully you. It’s your money!Strict and specific rules and regulations govern the broker’s activitiesand recommendations, and are there to protect you!
The Background CheckIt’s been said that an ounce of prevention is worth a pound of cure. The NASDmonitors complaints about every broker and brokerage firm. A call to NASD (800289-9999) may provide interesting information—good or bad—that will lay bare abroker’s history. Plus, it’s confidential.
THE FINANCIAL PROFESSIONALOutside of the most visible arena of the brokerage community is another genre of financial professionals. They sometimes offer total financial planning or promiselong-term planning on an ongoing basis. Just like brokers, their range is substantial.Some offer monthly investment options as a way to save. Others provide options,annuities, and tax-deferred strategies involving insurance products. It can be confusing, especially if you start getting conflicting advice from different investmentprofessionals.
Registered Investment Advisers (RIAs)These individuals have passed a test that permits them to declare that they are Registered Investment Advisers or RIAs. The test is not difficult, but the application of itsknowledge is serious business, for it generally implies something more than where toplace your IRA (individual retirement account) this year. The RIA typically is associated with a less visible brokerage firm, one that caters to one- or two-person shops.These broker-dealers “clear” transactions for their advisers—the ones they sold you.
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IRA (individual retirement account): A popular investment tool for currentlyemployed individuals that permits a contribution up to a maximum of $2,000per year. Some (or all) of the contribution may be free from taxation, dependingon the individual’s adjusted gross income and coverage by employer-sponsoredqualified retirement plans.
However, some advisory firms are very sophisticated and extremely valuable for theperson or company that wants to know more about where they are headed and why.The bigger outfits can educate an employer as to how to set up a retirement plan for hisor her company. Although brokerage firms can do this as well, the smaller RIA outfitsare in many ways well suited to address the needs of small businesses. In many cases,small businesses have vastly different needs than those of individual investors. TheRIAs can offer fee-based asset management, which means they are associated with amoney manager (or are money managers themselves), and they are compensated on apercentage basis of the assets under management. This method removes the danger ofovertrading, as RIAs need a large amount of money under management to make a living. They want to do exactly what you want or need in order to continue being paid.
Money ManagersPeople calling themselves “money managers” usually have a strong reason to believe they are highly skilled in the art of investing. They typically work on a feebased system (a percentage of assets under management). Did you ever wonderwhere the wealthy put their money? Professionals who are too busy making moneyto spend the time it takes to wisely invest it are the kind of individuals who utilizethe services of a money manager. There are plenty of money managers, too. To finda good one, meticulously check their performance records. Unlike a stock picker ata major brokerage firm, money managers cannot conceal their track records.Here are a few simple questions to ask when evaluating money managers:• What’s your track record (performance history versus the S&P 500)?• How long have you been in business, and what’s your background?• Do you offer different levels of risk and strategies?• How much do you currently have under management?• What references can you provide?Money managers, just like professional investors who direct pensionfunds and mutual funds, are all measured against the Standard &Poor’s 500, a group of stocks that represent a cross section of theU.S. economy. They either “beat the S&P” or they didn’t.
Most importantly, ask for a complete breakdown of the fee structure, althoughthey’ll most likely disclose their compensation scale upfront. The percentage they
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charge is on a sliding scale: The more they manage, the lower the percentagecharged. The fee is typically broken into four quarterly charges, paid at the beginning of each quarter.
Certified Financial Planners (CFPs)The financial professional who has the initials “CFP” after his or her name has completed a rigorous series of courses that encompass the entire spectrum of the investment world. For the record, it is typically done on an at-home basis, although thecurriculum is increasingly available through universities. Make no mistake, it takesan honest effort to complete and attain this status. The CFP can help with asset allocation, insurance coverage, financial planning, and more. The CFP’s compensationvaries from a flat charge to evaluate your current situation to fee-based management. Find the one you like the same way you find a broker: Ask around. Interviewcandidates carefully before disclosing your financial picture to them. Anyonegranted access to your financial inner sanctum should pass every sniff test you haveand then some. Avoid anyone who claims to be a CFP and doesn’t have it printed onstationery or business cards—it would be like printing “M.D.” on your card whenyou’re a hairdresser; it’s called fraud.Asset allocation: When you divide your money among various types of investments, such as stocks, bonds, and short-term investments, you are allocating yourassets. The way in which your money is divided is called your asset allocation.
Insurance ProfessionalsThe nature of life insurance policies and their place in the universe of financialplanning and investing brings to light another type of professional. This person isprimarily interested, at least initially, in determining the level of insurance protection you and your family or business may need.Insurance companies have played a vital role in America’s financial picturefor a long time. They offer such a wide array of financial products I will not evenattempt to evaluate them all here. But the industry hosts a variety of professionaldesignations that can assist you in piecing together your current needs and futuregoals. These people offer financial products that may be similar to those offeredby brokerage firms or mutual funds—many of them proprietary. Evaluate aninsurance professional as you would any other person attempting to help youinvest wisely.Proprietary investment: Investments offered exclusively to the clients of a specific insurance company, investment firm, or brokerage.
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