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December 9, 1998

Eyes on the Wise

A Life in the Day of a Stockbroker, Part 2
By V

Commission-Free Trades!

Sounds great, doesn't it?

Yes. It does sound great.

But I particularly disliked the Tuesday work nights when we were given the list of stocks that the firm had in inventory, which we could offer to our clients commission-free. Our firm of course compensated brokers for these trades -- actually, more than a normal reward -- and the client saw no commission appear on the confirmation. Now there's a good reason to buy a stock! You can, of course, bet that if the stock was stuck in our inventory (previously unsellable), then getting it at no commission was hardly a bargain.

Most clients had no clue of this.

So, from 6 p.m. to 8 p.m. we would telephone prospects at home during dinner, with this fantastic opportunity that just couldn't wait until tomorrow! "No, Mr. Jones, I don't have a fair-price target on it, but New York likes the stock a lot, and heck, it's commission-free if you buy it tonight."

What a deal.

Sales Contests
There were also the occasional sales contests for brokers, like the time a new government-securities mutual fund was rolled out. The fund invested in securities issued or backed by the full faith and credit of the U.S. Government and paid a higher interest rate than our firm's money market fund (hmm, did I mention market risk?). And, lucky customers, we were to tell them that there was no charge to transfer money into it (oops, did I mention the 12b-1 fees or deferred sales charge?).

Our managers provided us with a printout of all of our clients' money market balances and instructed us to start calling. After all, we were told, these non-investment savvy clients had money that could be earning 2% - 3% more. It would be irresponsible of us not to pitch them the new fund -- fees and all. The sales manager paced around the office jingling a bag full of coins as our progress was monitored. Each time we successfully sold someone on the fund, we received a bright and shiny, freshly-minted Susan B. Anthony dollar.

Pavlov was right.

Debt is Good?
By now you should have the impression that the typical broker is all about selling and generating commissions, either because of the quotas established by the firm or due to their own drive. Many have no other way to make a six-figure income. Most have college degrees, but not all. Any sort of financial training for the broker paid on commission really isn't as pertinent to her success as the need to make money... the love of selling.

A hungry broker is an aggressive broker.

For example, one day the manager asked that we turn in a list of things that we wanted to own in the coming year: a new car, boat, house. The theory here being that the greater one's financial obligations, the harder they are likely to work. My list was frowned upon. I listed that I wanted to save and invest.

Foolish of me. What a blunder.

Small and Long-Term Investors
It was during my third year that the firm implemented a new policy on commission payout. Typically, a broker keeps between 30% and 40% of the commissions generated. But the new policy reduced this payout to between 0% and 20% on trades under a certain level. In addition, accounts that had no activity for the past twelve months were assessed a maintenance fee -- under the presumption that it was good for clients to trade more? Hmm.

This did not go over well with all of our customers. We were expected to call our clients and attempt to tactfully say, in effect, "Suzanne, either buy or sell something and generate a commission, or we'll have to generate it ourselves with a fee charged to your account." The firm was basically penalizing brokers for having small or inactive clients.

No Cash-King investor need apply.

Managed Underperformance
Stockbrokers are first and foremost salespeople. The industry is built on this. I, and many others, view this as a conflict of interest. I believe that how they are compensated runs contrary to their fiduciary obligation to clients -- in a series of small and very large ways. Just think about the ongoing trading costs eating into the real rewards of compounded growth and you'll see that we're talking about no small violation of fiduciary duty from one client account to the next.

Now some firms, to help resolve this conflict, have developed managed asset accounts, where clients' money can be invested in up to one thousand different no-load mutual funds for which the firm charges an annual fee of up to 1.25%. Interesting. So, now you can invest in mutual funds (of which 90% underperform the indexes) and pay your broker a fee for his Wisdom and counseling (this, in addition to each of the funds' management fees & annual expenses).

I'm not sure that is the solution.

Senior Vice Presidents
Some of you may now be thinking, "Hey, how could a broker survive with the proliferation of discount commissions and no-load mutual funds?"

Well, according to one veteran broker I overheard at lunch the other day, no-load funds will, in the long run, cost more than load funds. I scratched my head about that one. Gee, they'd have to hide a lot of fees to get there.

I asked myself: Did the veteran broker really believe this or was it simply part of the sales pitch in the firm? But wait, I realized, he must know what he is talking about. After all, he is a senior vice president with his firm, which brings me to a final point. How do brokers get to be VPs? Is it investment knowledge? Testing? The amount of wealth they've generated for clients?

No. Sadly it's based on commissions generated per years of service. Now, one would think that in the financial services industry, the Peter Principle would prevail. It says that employees will advance to their level of incompetence, and then fail.

Given this, you would think that as brokers climbed the ranks through selling more and more, they'd begin to lose clientele. I doubt this very seriously. I question whether the average person that turns his fate over to a broker even knows how he is performing versus the market's average. I know that some brokers will say that the VPs have risen through quality performance for their clients. Rather than argue this point, why don't the firms just publicly list the annualized investment performance, broker by broker. That way customers can understand how and why promotions and compensation are doled out in the industry.

Taking Responsibility
By now you're probably wondering what all of this has to do with the Cash-King portfolio. Well, if you're a Cash-King investor, you are not a good prospect for most brokers, at least not as a long-term client.

Bottomline, the only person that can take personal and unbiased interest in your investments and hence your future is you. Even if you work with a professional, you must be vigilant. Ask questions. Get performance reports. It's your nestegg, college savings, and retirement. Remember that generating unnecessary and excessive commissions, capital-gains taxes, losses, or short-term gains adds nothing to achieving your goals. In addition, the only thing worse than an ill-informed investor, is one that thinks he knows it all, but actually doesn't.

I personally have learned ten times more in my three years of reading and following The Motley Fool than I ever did in my three years as a stockbroker. I still don't know it all, but I learn a little more each day. In fact, perhaps the Gardners' next book should be titled You Can Know More Than You Think, because if you follow the Foolish plan, you'll know more than the majority of stockbrokers. I'm sorry to sound so outlandish there, but it's simply true.

The Dow Dividend Approach coupled with Cash-Kings is the core to my investment plan. I have more exciting holdings in some of the Fool Port and Foolish Workshop mechanical picks, but the Dow Dividend/Cash-King combination provides my base.

With that I'll close and leave you with the top ten reasons to take charge of your finances and the reasons that I think Cash-King Investing makes so much sense:

My Top Ten Reasons for Cash-King Investing

1) Restful nights, with large and solid, brand-name companies.
2) Knowing why you own an investment.
3) You might only pay a handful of $8 commissions over a twenty-year period (or longer), regardless of the size of your account.
4) Tax-deferred growth -- it's not to be underrated.
5) You won't have to pay inactive account fees.
6) No broker calls during dinner.
7) You can smile at the broker recommendations matched with the analysts' short-term upgrades and downgrades.
8) You won't have to make investment-of-the-month decisions.
9) You won't make any high-commission-generating option trades.
10) You will be taking responsibility for your own future.

Fool on and thanks for having me!

- V.

I presume this series will inspire some (or many) to share their insights into this industry -- both from the inside and outside of it. The Motley Fool is all about open dialogue, free thinking, and learning about this subject together. I expect that the Eyes on the Wise message folder will help hold the industry accountable, as well as remind us that there are many great financial professionals in every rank, but that, in many cases, the system obscures their hard and honorable work.

Please drop by the Eyes on the Wise folder if you're moved to speak. And Fool on!

Tom Gardner

Eyes on the Wise Message folder

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