5 Things Your Broker Won't Tell You

Adam Bold

You might have an investment advisor or broker who has established a plan that will put you on the right track to meet your goals. Still, you should be aware of some important factors that could affect your financial plan. For those of you searching for an advisor or broker now, these points are key to understanding how their business works and how they can affect your money.

1. Each time your broker or financial advisor sells you investments from XYZ Co., it may pay him or her a commission for using its products.

Many financial advisors accept extra compensation from companies in exchange for selling their investment products. Sometimes, advisors use products exclusively from one company. The extra compensation can include everything from golf balls to trips to exotic locations. It may also include expense-paid client events and due-diligence meetings. Is this in the best interest of investors? No--and it doesn't matter if the compensation is disclosed.

Some investment companies even pay "shelf-space" fees to advisors, which means advisors and firms accept compensation simply for making the paying firms' products available for their clients' accounts instead of using independent research to determine the best investment products. While disclosure of shelf-space fees is required in a prospectus, that doesn't justify the practice of paying or accepting these fees.

Before buying an investment, ask your broker or advisor if he receives a commission or other benefits for recommending that product.

2. After a broker-dealer sells investments to you, he has no legal obligation to monitor them.

Studies have shown that many investors, even experienced ones, aren't able to distinguish the difference in services available from a broker-dealer (registered representatives) and Registered Investment Adviser (investment advisors).

Both registered reps and investment advisors have a legal responsibility to make sure the investments they sell are appropriate at the time of purchase. For the broker-dealer, the legal obligation applies only at the moment of the transaction. For the investment advisor, however, the responsibility is in place every day the client owns the investment and remains a client of the firm.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (see more here and here) that was passed in July 2010 gives the Securities and Exchange Commission (Toronto: SEC.TO - News) the authority, but does not require it, to impose a fiduciary duty on brokers, which means the advice must be in the best interest of investors. However, a broker is still not required to monitor your investments.

3. A broker sells investments you may not need; they might not fit your investment plan.

Many investors end up with a random collection of investments rather than a strategic allocation of assets. I get countless calls on The Mutual Fund Show from people who tell me they're ready to retire and their advisor wants to sell them a variable annuity. They get no road map or investment plan for getting them to retirement--or through the rest of their retirement. They may get some information on the benefits of the annuity, but they're not getting a full explanation of the potential pitfalls.

Do some research on your own before purchasing an investment product to make sure it fits in your financial plan and will help you reach your goals.

4. Your broker has no particular expertise in investment products.

When I worked at one of the national brokerage houses early in my career, each rep sold everything, including mutual funds, municipal bonds, stocks, commodities, etc. Most brokers did not have a particular expertise, and they weren't concerned with how much they knew about the product they were selling. Their primary concern was meeting a quota. The sales pitch was often more important than the merits of the investment.

When advisors earn any designation, they're required to take continuing education and agree to adhere to a code of ethics. They're like doctors who practice in certain areas of medicine as opposed to a general practitioner. Would you want your family M.D. to operate on your heart?

Check your advisor's credentials and ask him which products he knows best. For example, mutual fund investors can look for one of two designations--Chartered Mutual Fund Counselor (Other OTC: CMFC.PK - News) or Certified Fund Specialist (AMEX: CFS - News)--indicating advisors have taken extra training and education in all areas related to mutual funds.

5. Your broker is allowed to sell only certain securities or products, so that's what he'll recommend.

It makes sense that registered representatives sell only what they're licensed to sell. I wouldn't buy life insurance from anyone who isn't licensed to sell it. What doesn't make sense is when someone licensed only to sell insurance recommends an insurance product such as a variable annuity to someone who wouldn't benefit from it.

Along the same lines, an advisor with XYZ Fund Company, for example, understandably is going to sell only proprietary products. It wouldn't be in XYZ's best interests if its advisors were selling investments from competitors. I understand that. But that doesn't mean it's in their clients' best interests.

If your broker is not familiar with a product you're interested in, ask for a referral for someone who knows the product inside and out and how it could affect your financial plan. Every investor wants the choice of the best, most appropriate investments that will help them achieve their financial goals.


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