How to identify bad portfolio management advice if you use a full-service broker

Watch out for these examples of bad portfolio management if you use the services of a stock broker.

Finding a good full-service stock broker is hard but not impossible. Some successful investors view their brokers as a valuable source of investment research, information and advice. But they keep in mind that brokers operate under the potential for enormous conflicts of interest. That’s why they need to carefully assess a broker’s advice before acting on it.

We’ve heard lots of bad portfolio management advice given throughout the years. Read below for examples of it, and ways to manage your portfolio with more success.

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Be aware of these bad (but not uncommon) examples of portfolio management advice

Here are 3 practices you’ll never see from top stock brokers:

  1. Conflicts of interest: Some brokerage firms offer portfolio management for a yearly fee of perhaps 2% or so of the client’s assets, rather than charging trade-by-trade commissions. This is supposed to eliminate a conflict of interest over commissions between the stock broker and the client. But it’s not always an attractive arrangement for the investor. After all, brokers and their clients have a variety of conflicts of interest, apart from those related to brokerage commissions.
  1. Stressing low-risk, low-return, high-fee structured products in client accounts: These are created when brokerage underwriting departments take genuinely desirable securities and slice and dice them into what you might call Frankenstein investments. These investments come with special characteristics that make them superficially attractive to investors, yet far more profitable for brokers. A good example is principal-protected notes where returns are tied to a stock market index.

You may not lose much money buying these investments. You may even make a few dollars. But it is certain that these investments will generate big underwriting fees like any new issue, followed by a string of management fees. When the structured investment gets redeemed in five or seven years, or sooner, the broker gets an opportunity to sell the investor something new.

  1. Aiming for stability rather than growth: In response to suffering losses, many investors become much more sensitive to risk, or even to fluctuations in the value of one of their investments. Bad brokers respond to this fear with supposedly sophisticated strategies that bring great portfolio stability. However, this kind of stability costs money. It can virtually eliminate any chance of a significant long-term profit.

There’s one type of portfolio management advice worth following if your broker is among the best

In the long run, the best way to cut commissions is by sticking to high-quality investments and making fewer transactions. If you do that, along with diversifying across most if not all of the five main economic sectors, and downplaying or avoiding stocks in the broker/media limelight, you are following our Successful Investor approach. We feel it’s by far the best way to invest. Fewer trades also improves your tax deferral. For instance, suppose you buy an investment at $10 and it goes to $20. As long as you hold on, the entire $20 keeps on producing dividends and capital gains for you. If you sell, you’ll have only $16 or so to reinvest after paying capital-gains taxes and commissions.

If your broker can help you invest successfully in high quality stocks, and do it consistently, the extra commission cost per trade is probably worth it.

Bonus Tip: Trading online through a discount broker is now the preferred option for many investors—but this portfolio management advice has risks as well

Several years ago we asked our website visitors whether they trust the advice they get from their stock broker. Aside from a yes or no option, we gave visitors a third choice: “I trade online through a discount broker.” Seventy-five percent of the poll’s respondents selected this answer.

The main advantage of switching to a discount stock broker is lower commissions. And commission rates can be even cheaper if you trade stocks with your discount broker online, as opposed to placing orders over the telephone.

Although lower commissions are a plus, there is reason to be cautious. Low commission rates sometimes lead investors to trade a great deal. 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, of course, but that’s not the same thing as making money. And, if you stumble onto an investment that has a huge rise ahead of it, you may wind up selling just before the move begins.

What is the worst portfolio management advice you’ve heard from a broker? How did you respond to it?

In the past, how long has it taken you to realize you were working with a less-than-stellar broker?


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