Is Your Broker Acting In Your Best Interest?

As an investor you depend upon your broker for critical information and advice. But far too often these individuals are more interested in lining their own pockets than helping you fill yours. So how can you tell if your broker is looking out for your best interests? In this article, we'll give you some clues to help you determine whether your broker is looking out for you or if you should be looking for a new broker.

Frequent Contact or Needs Analysis
Good brokers will maintain regular contact with their clients. They will call their clients in both the good times and the bad. They will inform their clients if they think that any change in portfolio strategy makes sense, or if a new research report that the client might be interested in is issued by the firm. (To continue reading, see Picking Your First Broker, Shopping For A Financial Advisor or Research Report Red Flags.)

Most importantly, a good broker will talk with clients at least twice a year about their overall finances. Specifically, the broker will discuss the client's income and ability to save, as well as any longer term goals. The broker will then review any plans that have already been initiated, such as retirement plans or 529 plans for college savings.

How often should your advisor be in contact with you?

There is no definite answer to this question. But if you aren't hearing from your broker at least monthly, it may be time to find another advisor. If you have contacted your broker and you don't receive the courtesy of a response within a day - preferably within a few hours - it might be time to seek an alternate broker. (To learn more, see Brokers and Online Trading and Tips For Resolving Disputes With Your Financial Advisor.)

Unusual or Excessive Trading
The type of account you maintain should reflect the investment style you chose when you filled out your new account paperwork. In other words, if your goal was capital appreciation, you should be invested in stocks or mutual funds. If your goal was income, your funds should be invested in income-generating assets such as bonds. Any investments that don't fit in with your goals should be considered suspect.

Another big concern is "churning." A good broker will actively manage your account, however, your broker shouldn't be trading in and out of securities too frequently, or overtrading, unless you specified your desire that your broker continually trade the market at the outset of your relationship. Excessive trading generates large commissions, which will reduce your principal and only serve to make your broker richer. (To read more, see Understanding Dishonest Broker Tactics.)

What amount of trading is considered excessive?

Again, there isn't a tangible figure that has been defined by the Securities and Exchange Commission (SEC) or the Financial Industry Regulatory Authority (FINRA, formerly the NASD). Suffice it to say that any trading that eats into your principal and adversely affects your portfolio returns, or which deviates from your investment objectives, should be questioned.

Slacker or Professional?
Some brokers bolt for their office doors as soon as the market closes at 4pm (EST) every day. Others stay late so that they may speak with their clients when they return home from work. True professionals will also pursue a path of continuing education. They may seek and apply for other securities licenses, and/or become involved in educating the community.

Remember, as an investor, your job is to make sure that your broker is doing his or hers. After all you are the one paying the bill. Ask your broker if he or she is pursuing any credentials. Brokers who seek to further their qualifications often make better brokers over the long run. Those who put minimal time into their work may be hoping to make a quick buck. If this is the case, it is less likely that your best interest will be a priority.

Also, make sure that your broker or advisor is living up to his or her promises. If not, confront the broker. If you do not receive a satisfactory response or see a corrective action, it's probably time to find another advisor. (To see why being lazy can get you high returns, see How Portfolio Laziness Pays Off.)

Pushing House Securities or Speculative Investments
Brokerage firms sometimes hold positions in certain stocks or bonds that may not be of the highest quality. They know that they can't dump them on the open market, or the selling pressure will collapse the security's price. Instead, they often offer incentives, such as higher payouts, to their brokers to push these stocks or bonds to their clients over time.

How you can you prevent this from happening to you?

Ask your broker directly if he or she is getting any special commission on the sale, or if the security is a house stock or bond. Of course, you may not get the truth, but if your broker lies to you and the investment ends up going south, you may have a viable arbitration case against your broker. Another suggestion is to do your own homework. Peruse the web and see whether other analysts are following the company. If the stock isn't actively followed by other big banks, the security may be too speculative in nature. This could be a sign that the only reason your broker is asking you to buy it is because he or she will get a big payday when you do.

Lastly, be on the lookout for stocks with a low float. In other words, be wary of brokers who want you to invest in companies with very few shares that trade on the open market. This is because low float stocks are usually more volatile. Furthermore, these companies probably have only a few market makers (if it is a Nasdaq stock). The risk here is that the brokerage firm is making a large spread on your stock (the difference between the bid and the ask price), while you are left holding shares in an illiquid company. (For more insight, see The Basics Of Outstanding Shares And The Float.)

As an investor you need to benchmark your portfolio's performance against the performance of fund managers or an index such as the Dow Jones Industrial Average (DJIA). Why is benchmarking so important? Because you need to make certain that your investment performance isn't lagging behind the broader market.

To be clear, this doesn't mean that your portfolio won't take a hit every once in a while , or that your broker won't underperform the market from time to time. The purpose of benchmarking is simply to make certain that your broker's performance is on par with the industry average over time. If they don't perform the same or better, why not just invest in index funds, which have low expense fees. (To learn more about index funds, see The Lowdown On Index Funds and our Index Investing tutorial.)

In short, be a detective. Ask your broker or advisor questions. If he or she is underperforming the market, ask them why. If your broker isn't communicating with you on a regular basis, insist on a meeting. If he or she refuses or makes an excuse, consider seeking another advisor. Lastly, make sure your broker is giving you added value. You are paying big commissions, so make sure you get your money's worth. Remember, it is your broker's job to make you money - it is your job to make sure that you have the best advisor possible.

For related reading, see Find The Right Financial Advisor.