by Jordan Wathen | May 20, 2019
The financial industry is rapidly changing, and the traditional stockbroker as we know it is evolving as well.
You’ve likely seen stockbrokers portrayed in movies as men wearing suits, picking up their phones and dialing their clients to tell them about a new hot stock tip. Though these portrayals are accurate, the financial industry is rapidly changing, and the traditional stockbroker as we know it is slowly going extinct.
Below, I’ll explain what stockbrokers do, and how they compare to registered investment advisors (RIAs) and online discount brokers.
There’s no way around it: The primary job of a stockbroker is to… well, act as the broker for the sale of stocks and other investments. A stockbroker works on behalf of an investment firm, generally earning a commission for selling stocks, bonds, and mutual funds to investors. (Stockbrokers who work at broker-dealers can and often do have the title “financial advisor” rather than “broker” or “stockbroker.”)
A stockbroker is to a broker-dealer what a broker or agent is to an insurance company. Just as you wouldn’t expect an insurance agent to send you to GEICO (GEICO doesn’t pay agents commissions like other insurance companies do), you shouldn’t expect a stockbroker at a broker-dealer to sell you a full range of products from other investment companies, either.
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In that sense, the stockbroker’s most important job is to find people who have money to invest and convince them to buy the products he or she is selling.
There are three things that define the prototypical stockbroker:
Commissions and conflicts are the hallmark of the traditional broker-dealer, and it’s one reason why stockbrokers are slowly disappearing. Though you can get a fair deal from a stockbroker, the reality is that they are paid on commission and typically sell just one company’s products, just like any other salesperson.
Sometimes, the commissions you pay a broker are clear and obvious. For example, if your broker charges $50 to place a stock trade -- many brick-and-mortar brokers can charge even more than that -- then you know you’ll pay $50 on top of what you pay for the stock.
Some commissions are less obvious. For example, some mutual funds carry what’s known as a sales load, which is deducted from the amount you invest to pay commissions. In an extreme case, you might decide to put $10,000 into a mutual fund recommended by your broker, of which $525 is deducted and paid to the brokerage firm, and $9,475 is put into the fund. Of course, there are many no-load funds out there, but brokers have financial incentives to sell funds with loads because they make more money doing it.
The traditional stockbroker role is disappearing, as old-school brokers are getting replaced by a growing number of “registered investment advisors,” or RIAs. A registered investment advisor is not a salesman and is generally held to a higher standard when selling investment products to investors than a broker-dealer.
RIAs are generally in the business of selling advice, not financial products. People typically hire RIAs on a flat fee as a percentage of their wealth each year, or simply on an hourly basis, to help them make informed decisions about how to invest their money.
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These are the defining elements of a registered investment advisor.
Pay attention to how an RIA advertises its services. A “fee-only” advisor is one who is only compensated in the form of fees you pay them directly. Advisors who advertise themselves as “fee-based” advisors can and do make their money from fees they charge clients, but they can also collect commissions for selling certain financial clients.
It goes without saying that many people turn to RIAs for conflict-free advice, and thus stick to true “fee-only” RIAs to minimize conflicts of interest. When you, and only you, pay your RIA, your advisor has every reason to put your interests above those of any mutual fund company, insurer, or another financial institution.
More and more investors are choosing to manage their portfolios on their own by using online discount brokers to minimize the cost of investing and maximize the choices available to them. The big advantage of an online discount broker is that they are downright cheap. Whereas a traditional broker-dealer might charge you $100 for a stock trade, virtually all discount brokers charge $7 or less for that basic service.
There are three things that define a discount brokerage service:
Even as a discount brokerage customer and a proponent of DIY investing, I’m willing to admit they aren’t for everyone. Many people prefer a real human to help craft a retirement plan and build a thoughtful investment portfolio for them.
Guidance from a broker-dealer or RIA can be especially helpful for people who have complicated financial lives -- multiple business interests, large amounts of money, complicated trusts to pass wealth on to family members, and so on. Those complexities make it easier to justify hiring the services of a full-service brokerage or RIA.
But for the average person who just wants to open an IRA to start saving for retirement, a discount broker is hard to beat, especially for people who are just getting started. Whereas most RIAs have six-figure minimums to hire their services, discount brokers allow you to get started with as little as $1.
Naturally, many people start saving with a discount broker in their younger years, and later, if they want personalized help as they near retirement, they move to an RIA or other full-service financial planner. For obvious reasons, it doesn’t make sense to hire an expert for $250 an hour if you only have $5,000 to invest. On small amounts of money, minimizing expenses is arguably the most important thing you can do to improve your investment performance.
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