Chapter 11
Stockbrokers and Advisers
In This Chapter
• Swing and position traders can use retail brokerage firms
• Minimum expectations of an online broker
• Examine all costs, not just commissions
• Should you use an investment manager or financial planner?
Not all active traders require Nasdaq Level II price quotes and live streaming news feeds. You can still practice some forms of active trading using a regular online retail broker. These firms execute trades for all types of securities with proper licensing. Traders can find firms that offer rapid execution of orders and low commissions. Full-service brokerage firms have morphed into a type of investment management service that works for some investors who want a professional looking after their assets. Many active investors would rather manage their own accounts, but for those who don’t or who want some extra help, there are investment management firms or services that offer assistance and/or guidance.

Retail Stockbrokers

Retail stockbrokers are familiar to anyone who has been involved in investing—and many of the names will likely ring a bell with others because of the advertising they do. First and foremost, these firms execute your trade orders—buy, sell, and so on. You cannot trade securities except through a firm that is licensed to do so for you. Brokers are required by regulation to act in your best interest, although with online order entry it is often hard for a brokerage to know what is right for you.
Stockbrokers are strictly regulated because they handle your money and, in some accounts, have Retail stockbrokers provide gen- the authority to enter trades without the owner’s eral brokerage services to non- approval. All of the principal employees of a broker professional investors and traders. are licensed to handle certain types of transactions Retail brokers can adequately and/or to supervise others who do. Later in this serve the majority of people who chapter, we’ll look at the regulatory agencies involved invest or trade. and what recourse customers have if there is a problem.

A Brief History

The stockbrokerage industry was once dominated by a handful of powerful firms with offices in many cities around the country. During this period, you had to establish a personal relationship with a stockbroker, which usually meant going into his office and opening an account. From there, you could call in your orders to buy or sell. The broker would frequently present you with ideas or opportunities he thought were attractive. Some people turned over their assets to the broker and gave him the authority to invest on their behalf—these are known as discretionary accounts. Commissions were outrageous, often several hundred dollars for a 100-share transaction.
Market Place
An industry once noted for its snob appeal as much as its investment advice, the brokerage community is now highly competitive and market driven.
In May of 1975, the Securities and Exchange Commission abolished the fixed commissions and let the market set rates. Charles Schwab was the first to see the potential of discounted commissions and founded the first discount stockbrokerage. His company is still one of the industry leaders. Others soon followed and the stuffy Wall Street firms either adapted to the new world or disappeared. Commissions went from the hundreds per trade to the low teens and less.
However, when commissions dropped so did much of the “service” that had been part of the full-service brokerage. This included access to research, a person to help you with investment decisions, and so on. While many investors and traders embraced the no-frills discounted commissions approach, others wanted some assistance in investment and trading decisions. This led to brokerage firms forming investment management practices.
This service operates under different trade names and may offer different services by vendor, but it is a step back to more personal contact with the customer. As we’ll see below, it also offers a different method of compensation.

Basic Brokerages

Many active traders (swing and position) simply need a way to execute stock orders. They don’t necessarily need intraday prices and use protective orders to make sure their losses are minimal if the trade goes bad. These active traders look for a broker that offers a reliable and inexpensive way to place orders. Once in place, they can follow the progress of the trade with regular quotes.
Swing traders will want access to live quotes (not the delayed quotes you see on many free news sites). Most brokerage accounts provide Level I Nasdaq quotes as part of their service. If not, you can find these quotes in a variety of places, most free. This is not a universal standard. There are some swing traders who are very aggressive and want intraday prices, in which case they will need a broker that can provide that level of service. A retail broker may not be adequate for these traders, in which case a trading platform with a direct access broker (see Chapter 12) is in order.
Basic brokerage firms offer deep discounts on commissions and can serve active traders’ needs by keeping their trading costs low.
If what you need is a firm that will provide you the means to place your stock orders and not screw them up, the basic brokerage firm/account may be for you.
Trading Tip
Many of the deep discount brokers offer even better deals for active traders who trade a lot and don’t need customer service or investment advice.

Tiered-Commission Brokerages

Many brokerage firms have staked out a middle ground between the deep discounters and the modified full service brokers. These firms may offer some form of investment advice, but usually not an individual dedicated to your account. They have comprehensive research offerings or pair with an outside service to provide clients with research and analysis.
These firms may offer very low commissions, usually a tiered commission structure that is keyed to the number of trades you make. An active trader who wants access to research and someone to bounce ideas off of every once in awhile may find these firms’ offerings are a good fit.

Full-Service Brokerages

While full-service brokerage firms as they existed in pre-1975 days are gone, you can still find many firms that are eager to work with you and your assets. Some traders may value the access to an investment professional for assistance or want to tap proprietary research that is available to clients with these accounts. What the firms are hoping you will do is put all your investment assets under their management (discretionary or not). For an annual percentage fee (usually paid quarterly), they will give you unlimited trades, access to a professional investment adviser, and other value-added services. The annual fee is determined by how much you place in assets under their management. One to two percent of assets under management per year is common.
Margin Call
What happens if your assets under management drop below the brokerage’s minimum threshold? Before you sign on with an asset manager, make sure you won’t be hit with retroactive fees and so on.
Traders may find this arrangement more beneficial and economical, but watch for extra fees and limits on trades of access to investment professionals. These can change the benefits of this type of account.

Your Choice

Many of the leading retail stockbrokerage firms offer accounts that range from deep discount to investment management. Your choice of a stockbroker should include the services offered as they fit your particular trading needs and as the firm qualifies in the other areas listed below.

Evaluating a Broker

Traders look for certain qualities in a brokerage firm. Not all traders rank qualities the same, but most would agree on some basics. The major stockbrokers offer a wide variety of services and are usually competitive in pricing for comparable services.
However, it is worth your time to shop. Most will let you try their website’s interface through a demo account and many will let you paper trade to get a feel for their system and online trading. If this service is offered, take some time to try out the site. In many cases, you’ll quickly get a sense of how well you can work with it—or not.

Working Online

Since most, if not all, of the interaction occurs through the company’s website, it is important for the trader to find it comfortable and easy to navigate. The response time should be acceptable even during heavy trading. Given the popularity of BlackBerry mobile devices and other smart phones, the company should offer a robust mobile service. The trader should have a phone number that she can call to place trade if away from her computer or if there is a problem connecting with the website.
One of the harshest criticisms of online brokers is their vulnerability to an Internet disconnection or service disruption. Active traders who specialize in short-term trading often have a redundant connection as a backup. That may be overkill for swing and position traders, especially if they always use protective stock orders. However, in stressful market events of the past, online brokers have been swamped and unable to keep up with orders coming in via the Internet. Orders were running hours behind and in severe cases computer servers crashed, rendering the website inaccessible.
Market Place
In extreme market conditions, no broker may be able to keep up with orders. However, a very active day is not an extreme market condition. Consider it an extreme market condition if the exchanges drop five percent.
It is important to have a phone number, preferably one that is only available to customers, so you can call in orders if the Internet connection is lost or the computer system crashes. A phone line is not a good solution if there is no one on the other end to answer it. These are important questions to ask potential stockbrokers.

Ease of Use

It is remarkable that in this day and age, websites that are supposed to be “self-service” are designed so poorly that traders have a difficult time figuring out what they are supposed to do. There is nothing more frustrating than filling out a screen of information and clicking on “submit” only to get an error message because you put the date in the wrong format or some other silly mistake. Websites that don’t tell you exactly what to do and in what format waste your time and could cost you money as you struggle to get a trade entered.
Navigation through forms should be intuitive, but with directions. Navigation from page to page and section to section should also flow logically and you should always be able to get back to the home page with one click from any other page. Accomplishing any task from making a trade to changing contact information should not take more than a few clicks to get to the correct screen.


A critical factor in picking a stockbroker is how reliable is access to your account. If a storm knocks out the company’s electricity, do they have a backup generator? What are the contingency plans if there is a natural disaster or other problem that affects only this firm?
Reliability goes beyond physical integrity—it includes fiscal integrity. Stockbrokers are highly regulated but you don’t want to deal with a company that has a lengthy history of complaints from consumers and trouble with regulatory agencies. In the section below, you will learn which agencies regulate the securities industry and how you can check on a firm’s background.

Advice and Management

If you are looking for advice and management skills from the stockbroker, how comfortable are you with what they offer? In some cases, this may be hard to determine in advance. However, firms with a history of giving inappropriate advice or mismanaging clients’ funds will have a history with regulatory agencies. Stockbrokers are required to suggest investments that are appropriate to their client. The “prudent man” test is a generic appropriateness qualifier for investments. Stockbrokers are supposed to ask themselves if a prudent man would recommend this investment to a particular client.
For example, it would be inappropriate to suggest to an elderly widow that she invest significant assets in a speculative high-technology stock. That same investment might be fine for a 30 something, however.
Trading Tip
Before you sign on with an investment adviser, ask about their approach to investing. If all you get are a bunch of clichés, you’ll probably want to interview someone else.
Another concern is stockbrokers recommending securities of companies they represent in other capacities. Often, large brokerage firms also help raise money for companies through secondary stock offerings and other means. When stockbrokers push these products, there is a conflict of interest—the stockbroker does not have the best interest of the retail customer first. There were several scandals on Wall Street where analysts for major brokerages were recommending the stock of clients.
If you are working with a stockbroker who is offering advice or investment suggestions, you should always be asking yourself who benefits from this investment more—the stockbroker or me?

Keep an Eye on Costs

When shopping for an online broker, active traders should be aware that advertised prices per trade might not be the whole story. Read all material carefully to determine what other fees or charges may apply. For example, you may see a very low per trade cost, but on further examination discover that you have to make a minimum number of trades to receive this rate. For an active trader, meeting this minimum may not be a problem. However, you shouldn’t be locked into one rate that is dependent on making more trades than you planned to make.
Another popular marketing tool is free trades up front. The firm will give new customers 50 or more free trades to get them started in the account. However, these free offers often have a time limit for making the trades, which may not meet your calendar of events.
If the stockbroker provides certain quotes from the exchanges, you may be responsible for paying exchange fees. Exchange fees can run from a little over a dollar to more than $20 per month depending on the exchange and the depth of prices you want to receive. Some brokerages will waive the fees for large accounts.
Another common fee is an account maintenance fee, which may be charged on a quarterly basis, depending on your level of activity. This fee is supposed to cover preparing statements, mailings, and so on. If your account is dormant for a prescribed period, you may have to pay an inactive account fee.
Trading Tip
Active traders are effectively operating a business. As such, they must watch expenses. What may seem like just a few dollars in fees now will over time eat away at your return since they reduce your profitability.

Regulatory Agencies

The securities industry is highly regulated, yet with all the scandals that seem to fill the headlines, you may wonder if that is so. Unfortunately, people bent on cutting corners will usually find a way. The good news is most of them eventually are caught. It is the practitioners who dwell in that area between legal and illegal that cause the industry so much pain. These are the stockbrokers who put people in inappropriate products, who trade too often in discretionary accounts, who push company products over the customers’ best interest, and so on.
The regulatory structure begins with the United States Congress. It created most of the structure and it passes major laws that affect how the industry operates. It also authorizes budgets for the Securities and Exchange Commission and other agencies involved in regulatory duties. The SEC is the top regulatory agency responsible for overseeing the securities industry. It registers new securities and handles all the filings that public companies must make, such as annual and quarterly reports.
The SEC also oversees all of the stock exchanges and any organization connected with the selling of securities. It also has a strong anti-fraud unit that monitors advertising and marketing to make sure companies comply with strict rules concerning the sale of securities.
Margin Call
The SEC aggressively prosecutes securities professionals who take advantage of the investing public. They also will prosecute individuals who attempt to trade on inside information or commit some other type of security fraud.
At the next level is the Financial Industry Regulatory Authority (FINRA). It was created in 2007 when the National Association of Securities Dealers merged with the regulatory functions of the New York Stock Exchange. This is an industry self-regulatory body that is responsible for policing the securities industry.
FINRA set standards for stockbrokers and other industry professionals and licenses them after comprehensive examinations. It has the ability to fine individuals and organizations for unethical behavior and can revoke licenses.
The organization is usually the place customers can take complaints of behavior they feel is unethical or illegal. FINRA also monitors trading activities of member firms to detect illegal trading patterns and other illegal activity.
The individual exchanges also have sophisticated regulatory oversight functions within their own operations. These include monitoring trades and other steps to see that customers get a fair deal.
Individual states also have securities divisions, although they are usually not as sophisticated as the FINRA. Often they handle complaints and register securities that will be sold within the boundaries of the state, although this will vary from state to state.
The final step of protection is at the brokerage level. Each firm is required to keep certain records and perform certain checks and audits of the operation to make sure their brokers are operating within acceptable legal and ethical guidelines.

Do You Need a Financial Adviser?

Some traders find that they don’t have the time, energy, or talent to research and identify stocks for their portfolio, much less manage their money effectively. Their needs go beyond the scope of a stockbroker—they may need the services of a qualified financial adviser.
Most financial advisers want to look at your whole financial picture—all your income and liabilities. They want a complete picture of where you are financially so they can draw a map from where you are to where you want to go. Here are some of the benefits of using a financial adviser:
The big picture. A financial adviser will develop a comprehensive profile of your financial status. This profile will identify areas of strengths and weakness.
An unemotional assessment. The financial adviser will give you an unemotional assessment of what needs to be done. Money is an emotional topic for many people, which often leads to bad decisions.
Market Place
Active traders can lose sight of their overall financial picture if they are not careful. Retirement and estate planning are important exercises that can’t be put off.
Allocate resources. It is likely you have competing priorities, such as sending the kids to college while building a retirement fund. A financial adviser can help you allocate resources so both goals receive the appropriate share of dollars.
Minimize taxes. Most investment decisions carry some type of short- or long-term tax implication. Your adviser can help you shape your investments in a manner that keeps taxes to a minimum and more of your dollars invested.
Estate Planning. Careful planning will help ensure that your estate passes to loved ones in a manner that protects as much of its value as possible.
The plan may include options to reach your goals that involve different levels of commitment on your part (read that dollars). Generally, you can classify financial advisers two ways: by their method of compensation and by professional designations.

Method of Compensation

There are three basic ways you compensate financial advisers for their work: fee only, fee and commission or percentage of assets, and commission only. Each of the three methods has some good points and some weaknesses. In the end, you should choose the adviser you feel would do the best job for you and worry less about the method of compensation.

Fee Only

The fee-only adviser develops a comprehensive plan that lays out how you can reach your financial goals. However, it leaves the actual execution of the plan to you. The adviser doesn’t sell any products or services other than the plan itself. Fee-only advisers usually produce the most comprehensive plan since this is their sole product. Fee-only advisers charge more than other types of advisers since they do not take any other form of compensation.

Fee and Commission or Percentage of Assets

The second method of compensation of financial advisers includes a fee and commissions. The fee, which is usually substantially less than what a fee-only adviser would charge, covers the cost of building the plan and commissions cover the cost of execution.
A variation on this compensation plan involves an annual fee based on a percentage of assets in your accounts. The fee compensates the adviser for monitoring your investments and making recommendations. The fee-plus adviser develops a plan for the customer that lays out suggested strategies for reaching the customer’s goals. Because the fee-plus adviser receives compensation from executing the plan, the adviser is there to execute the plan. Fee-plus advisers may push certain mutual funds or life insurance products, for example, which may not be the best choice for your particular situation.

Commission Only

The third method of compensation is commission only. Financial advisers receive their only compensation from products they sell to you. I think you can see the inherent problem with this arrangement—it is in advisers’ best interests to sell you something. A person who works on a commission-only basis is a salesperson. However, this is not to say that you can’t work with someone on this basis. It will depend on the individual and your relationship.

Professional Designations

In many states there are no strict regulations regarding the terms “financial adviser” or “financial planner,” meaning anyone can print up business cards using those terms. However, several professional designations are protected.
The top designations you should look for are:
Certified Financial Planner (CFP). This is the top of the line in terms of professional designations. Before an adviser can carry this designation, they must complete three years of work in financial planning, take a course of study, and pass a comprehensive set of examinations. They must also meet certain ethical and educational standards.
Trading Tip
Active traders are less likely to need financial/investment advisers than the general public, but it may make good sense to employ an objective set of eyes to look at your total financial plan.
Chartered Financial Consultants (ChFC). ChFCs must take courses of study on personal finance and pass exams.
Certified Public Accountant (CPA). CPAs must pass exams on accounting and tax preparation to win the designation. However, you want a CPA who has also been awarded the designation Personal Finance Specialist.
If you decide to use a professional financial adviser, the most important considerations are the person’s integrity and your relationship. Method of compensation and other factors are secondary to establishing a level of trust that will allow you to work with the adviser in confidence.
The Least You Need to Know
• Retail stockbrokers work fine for many swing and position traders. These stockbrokers should meet minimum expectations of usability and reliability.
• Basic brokerages provide discounted commissions, while tiered commission brokerages offer more services but with fees tied to the volume of trades you execute.
• Full service brokerages charge much higher fees, but provide comprehensive investment services, including advice.
• The SEC and FINRA are the primary regulatory agencies that cover the financial markets, setting rules for financial disclosure and broker conduct.
• Be cautious of unadvertised costs that can increase your trading expense with retail stockbrokers.
• Some traders find working with a financial planner helpful.
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