I have read many posts and articles about Financial Advisor’s conflict of interest when it comes to clients investments, so I thought give a glimpse as an insider.
Although I do not sell investment to clients currently I have in the past and I have talked and analyzed many full service brokerage firms as they have tried to recruit me, for the most part they are all the same with some minor differences. So here is a look at how the brokers are generally trained and paid and how this could affect you negatively.
NOTE: We are talking about full service commission based investment brokers.
Brokers prefer Mutual Funds over individual Stocks
It is true that most brokers prefer mutual funds over individual securities.
The main reason brokers prefer Mutual Funds is because of commission, yes this does come very close to unethical. Mutual funds usually pay higher commission to the firm and therefore higher commission to the broker plus there are the trailer fees.
Example at a firm I used to work at:
If you had $100,000 and we would buy stocks, 10 stocks each $10,000 with it the total commission would be about $2500 to the firm and $1000 to the broker, however if this was in a mutual fund the commission would be about $5000 to the firm and $2000 to the broker. You see the conflict of interest?
As an added bonus brokers also get “servicing” fees as long as the client holds the fund, in stocks there would be no further commission until sold. These servicing fees range from 0.25% to 1% depending on the fund type.
The firms I have worked with always have some type of justification as to why mutual funds are good better options for clients; we receive “objection overcoming” training on how to deal with those questioning mutual funds.
The second and a more legitimate reason for preferring mutual funds is that investors usually do not have enough funds to have a diversified enough portfolio. If you have $50,000 there are only a few good stocks you can buy and you will lack proper diversification, however in a mutual fund you would be well diversified.
However one could buy ETF’s to get the diversification needed at a much lower cost. But this is not really encouraged by firms because of lower revenue. Whenever I would ask a trainer or supervisor about ETF’s they would say “oh no ETF’s are not good, nobody manages them” not a good enough reason for me.
No time to monitor stocks
Another important reason is that brokers do not have enough time to monitor each stock for clients. With mutual funds thing are much easier, generally brokers choose several mutual funds they will use for clients so monitoring it would not be as time consuming and even if it was time consuming there is an incentive, the trailer fees.
Investment Banking Client
Sometimes the firm maybe involved in underwriting of an issue or maybe involved in a private placement, and their brokers maybe asked to sell the investments to clients. The product may not always be a good investment for the client.
If the company is an investment banking client of an investment firm, the firm will be reluctant to issue unfavorable opinions about the company as they might lose the investment banking client. This can cost the investor large sums of money.
Full service brokerage is not for everyone, it is expensive. However not everyone has the time or knowledge or even motivation to do their own investing. If you are with a full service broker I hope you remember these points when discussing your investments. The firms and advisors are suppose to disclose most of the information, however by you asking questions you will make it clear that you are aware of potential conflicts of interest.
Note: This is a very general overview not all advisors are the same, I have worked with some great advisors who truly care about their clients unfortunately they are the exceptions.
Do you think Full Service Brokerage houses s put their needs before their clients? Any experience with any?
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For the money you don’t have in the markets, you’re probably going to want to find the best savings account interest rates that you can. An online bank will typically be able to offer better bank deals than your local bank because of their small operating costs. You should make sure to research the list of bigger online banks to make sure you find the best rate for your cash.