Brokers are hired-guns trained to sell securities. Research studies show that over 80% of all mutual funds are “sold” by commissioned brokers who will do whatever’s necessary to make the sale: withhold information and when necessary lie, cheat and commit unethical, often illegal acts to make their five percent commissions. For example, the New York Attorney General got settlements against Morgan Stanley for unethical brokerage deals that revealed how, behind the scenes, CEO Phil Purcell changed the venerable House of Morgan into a bunch of hack brokers using all kinds of unethical incentives.

Ever try to get rid of one of those pesky cold calls from a commissioned broker? That is, other than spewing expletives as you slam down the phone, screaming that you’re on the national-do-not-call list? Here’s an even tougher question: How’d you get rid of a real nice broker, who’s also a family friend, someone you hired several years ago—before you knew better—who you now realize has been pocketing big commissions and fees every year while your account’s losing big bucks during a bear/recession?

Normally I don’t think much about these questions, because I’ve avoided brokers since my old days at Morgan Stanley long ago. Why? Because you can always, always, find an equal-or-better no-load mutual fund. Every savvy investor knows that buying mutual funds through a broker is just throwing your money away because they provide nothing of value. And yet, the hard truth is that about 75 percent of all mutual funds are sold by commissioned brokers. So most people are dealing with brokers on a regular basis. Moreover, according to an AARP study most investors not only don’t have a clue about how much of their money their brokers are siphoning off, they never even ask for the information. For example, 88 percent of the people never ask their brokers whether the broker gets a bigger commission for one security than another. And so brokers take advantage of such behavior and make money at the expense of naïve investors.

I started thinking seriously about broker-related issues after my brothers read my book on “lazy investing.” They began quizzing me to see how smart I really was, and pick up some pointers for their investments. They wanted me to reveal my “secret,” so they could become one of the truly “lazy-rich.”

Great in business, but naive about brokers

Neither of my brothers really needed any advice from me about their own businesses. Both are quite successful, one as a restaurateur, the other in the oil business. But when it comes to securities, they’re no different that everyone else. Very few people know how to deal with the clever pitches of an aggressive, well-trained commissioned broker, who many critics and studies say operate with the ethics of “used car salesmen.”

And you can hardly blame them. After all, if they can talk you into buying $10,000 of their funds—and you fall for their pitch—then right up front they “earn” a sizable commission that goes toward the monthly payment on their house of car—easy money for doing nothing. Moreover, if, for example, they get a 5% commission on that $10,000 you pay them, then your nice broker pockets $500 and you have only $9,500 invested—so you’re already a loser.

So how can you protect yourself against these sharks? How do you know you’re not dealing with a con artist? They seem like such nice people. They have big smiles, belong to all the right clubs, a regulars in your church, coach the kids little league … but are they really, really earning their keep? Or are they clever hustlers doing nothing much but feeding off your portfolio?

Annual fees will eat your retirement nest egg

In addition to all those front end commissions that get siphoned off, you broker is probably also charging you an annual “management” fee for holding onto your securities—again, for doing nothing. And while a two percent fee may not sound like a lot, imagine the drain if you’re retired with a million dollar portfolio that’s invested in bond funds paying an average 6 percent. For example: You’re expecting $60,000 a year before taxes on that million bucks. But your nice broker also expects a two percent annual financial management fee. That doesn’t leave much for you after taxes. No wonder Dalbar Research data concludes that after taxes and fees most fund investors make less than inflation, but aren’t aware of it because the industry manages to hide essential information like that from investors.

The truth is, your nice, friendly broker-adviser really isn’t doing a darn thing to justify siphoning off one third of the investment income on that million bucks you worked so hard to accumulate the past few decades. In fact, most brokers offer virtually no value added advice to justify earning a front-end commission, especially when we know you can easily find a comparable low-cost no-load fund that’s equal to or better than the one he’s pushing. Hardly seems fair, does it? In fact, it isn’t fair. But unfortunately, most people never wise up to their broker’s clever games, even with the many studies by organizations like AARP. So here’s what I tell my friends, and other novice investors they can do to protect themselves when that nice friendly smiling broker starts his full-court press trying to convince you that you can’t possibly go wrong if you buy what he’s aggressively pushing at you using every high-pressure psych-ops salesman trick in his play-book.

First question: What funds and stocks do you own in your own portfolio?

After your nice broker-adviser balks on this one (which they probably will by telling you that they never disclose their personal net worth), then apologize and tell them you just want to know which specific funds and stocks they actually own, not his total net worth. And ask why each one was bought. And ask him to put the list in writing. Tell them you want to know all about his portfolio, all his securities, asset allocations, returns, and what their reasoning was in each case, including what was sold as well as bought. And tell them you feel this is valuable in your learning how to build a successful portfolio, as well as helping you learn about the thinking process of a savvy investor like them. Ask before you hire them as your broker-adviser. The truth is, most brokers make most of their money on commissions not investment returns. And they are as clueless as any other investor when it comes to their portfolio, unless they also invest in “lazy portfolios.”

Second question: Can you recommend some comparable no-load funds?

Tell your broker you may still buy the funds that he is selling. But first, you’d like him to give you some specific alternatives to compare his funds, so you can hear his specific rational for buying his load fund over the no-load alternative. And every time your broker makes any recommendations in the future, plan to ask the same questions and force them to explain why you should pay their commissions versus going with the no-load fund. In fact, before you meet with a broker, pick out a few simple no-load index funds and ask the broker to explain if he’s got comparable ones, and why he doesn’t recommend any. There are a whole bunch of other questions a novice investor could ask your friendly broker-adviser: Like do they get extra incentives for selling you certain funds, why you should buy one class over another, redemption fees, transaction costs, breakpoints that lower fees and commissions.

Never pay commissions, buy no-load index funds

But my guess is your friendly broker probably won’t even answer the first two questions in a way to satisfy either you or them … and they or you will just hang up before working together. More likely, once you get all the facts you’ll become a savvy investor and you’ll just go buy the no-load index funds all by yourself and save the commissions and fees. But be forewarned, brokers are masters at wearing down your psychological defenses and do not give up easily.

FirstPubDate: Jun’04