If you want to find out how to hire a stock broker who meets your needs, you need to watch out above all for conflicts of interest
A good broker is generally worth the higher commissions that he or she costs you, compared to dealing through a discounter. However, good brokers are hard to find. Many good brokers eventually move into money management. Many bad brokers manage to pass themselves off as good ones, at least initially.
Discover how to hire a good stock broker with the tips provided below.
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Learn everything you need to know in '9 Secrets of Successful Wealth Management' for FREE from The Successful Investor.
Secrets of Successful Wealth Management: 9 steps to the life you've always wanted, before and after retirement.
Look for these traits when considering how to hire a stock broker so you can profit more reliably
We feel your best way to profit in the long term is to buy a portfolio of well-established stocks that meet our Successful Investor criteria and make changes only when there’s good reason to do so. If you buy carefully to begin with, you may only have to replace 10% of your portfolio per year on average. Some years, you may not need to buy or sell anything.
This is best for you, but it provides a meager living for a broker—and only the best stock brokers will refrain from straying from this strategy and will avoid conflicts of interest, including the frequent selling of stocks.
Overall, the best stock brokers will focus on client profits, rather than their own.
How to hire a stock broker: Avoid brokers that will put you in conflicts of interest and you will improve your prospects for portfolio growth
I’ve often written that conflicts of interest are the greatest risk you face as an investor. This idea seems to make sense to most of our readers, even if they never thought of it that way before. But when I mention it to experienced investment professionals, most react in one of three ways:
- A blank look, as if I’ve referred to something that they know nothing about, or a sensitive issue they don’t want to talk about;
- An aggrieved or defensive look, as if I’ve raised a sensitive issue and they expect me to follow up with criticism of something they’ve done;
- A big smile, as if they know of an outrageous conflict of interest and are eager to share.
Recently I got response #3—a big smile—from a fellow portfolio manager. He told me about a new client who had previously been investing through a discretionary portfolio-management arrangement with a broker. Previously this client owned a portfolio of mutual funds with an average MER (management expense ratio) of more than 2% of assets. The broker sold him on the switch to a portfolio-management arrangement, because it would only cost him 1% a year (plus “standard” brokerage commissions).
Unfortunately, this kind of arrangement with a broker exposes you to many conflicts of interest.
When my friend took over the management of the account, a big part of his new client’s portfolio consisted of shares of a small, little-known, thinly traded stock with a modestly above-average dividend yield and an uncertain outlook. Buying any amount of the stock seemed questionable. It was hard to imagine why the broker-portfolio manager chose to load the client up with it.
The holding was so large that it dominated the client’s portfolio; the stock was so thinly traded that if the client wanted to unload, it could take months to sell the position into the market without driving the price down. When my friend asked why the broker bought so much of the stock, the client said the broker told him it was a special deal: he was able to buy the stock without paying commission. It turned out that this was because the stock was part of a secondary offering by the brokerage firm.
Tips on the alternative: a discount broker
Your bank is probably the best place to look for a discount broker. All of the “big five” Canadian banks have both full-service and discount brokerage arms. It’s also easier to transfer money between your bank account and your brokerage account if you have both at the same bank.
Commission rates are even cheaper if you use a discount broker’s Internet trading facility. Unfortunately, low commission rates sometimes lead investors to trade more than they should. They may assume they can’t lose because they can sell at the first sign of trouble. Being quick to sell can cut your losses, but that’s not the same as making money. And, if you stumble onto an investment that has a huge move ahead of it, you may wind up selling just before the move begins.
Bonus tip: Use our three-part Successful Investor approach to make your own stock investing decisions
- Hold mostly high-quality, dividend-paying stocks.
- Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
- Downplay or stay out of stocks in the broker/media limelight.
What types of conflicts of interest have you experienced in your relationship with stock brokers throughout your investing career?
What is your opinion of working with a stock broker as opposed to managing your portfolio yourself?