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Stockbrokers…Are You Better Off With Them Or Without Them?

By Marc Davis, Managing Editor
January, 2003

"Stockbrokers…who needs them?! is a refrain that I often heard during the heady stock market days of the late 90s when online trading was all the rage. After all, buying low and selling high seemed almost easy. Everyone was doing it.

Back then, I recall one television advertisement that offered wireless stock quotes on an array of 'must have' hand-held electronic devices. The commercial's perky voice-over proudly proclaimed: "Now you can trade from your living room, from your car or even from the bar!" Honest, I'm not making this up. Apparently, you could profitably flip stocks while driving through morning rush-hour traffic or while downing your third martini at any trendy downtown watering hole.

How times have changed!

When the market was frothing with what Federal Reserve Chairman Alan Greenspan once famously declared as "irrational exuberance," investors could seemingly do no wrong. Indeed, the ten-year bull market that started in March, 1991 was unprecedented in its duration during the last century. So many stock were trading at outrageous price/earnings ratios, it became the norm. Then there were the many high tech and Dot Com darlings that had no earnings at all but were nonetheless trading at hugely inflated prices. They were leveraging their share prices against the unrestrained promises of tomorrow.

For many online investors, particularly those who had never experienced anything but smooth sailing and sunny skies, it was as if the bull market would never end. Then it did. It ended abruptly in March, 2001. And the stomach-churning financial seas that ensued found most of these investors too inexperienced and shaken up to know what to do next.

Many found themselves sending out Mayday signals to financial advisors to help steer them to a safe harbor to ride out the recession. Only then did they begin to comprehend the truly volatile nature of the stock market. Before that, they had been making four or five figure investment decisions by themselves. After all, by cutting out the middle-man i.e. the stockbroker, they could save themselves anywhere between $50 and several hundred bucks on commissions. That was enough money to take their friends out to dinner to brag about how well their investment picks were doing.

However, now that has changed. Investors are finding that making their own investment decisions can prove very costly, regardless of how much money they save on commissions. That's not to suggest that stockbrokers or financial planners have all the answers. They, too, can make mistakes. But making you money is what keeps them in business. And that's all the incentive they need to diligently study the markets before making informed investment decisions on your behalf. So, what should you, the investor, look for in an investment advisor if you expect your money to be managed better than you can? Here are some tips:

• Choose a stockbroker who has been in the business for at least five years. According to Business Week, something like 75% of brokers throw in the towel within five years. That means that the remaining 25% have been successful and hard-working enough to beat the odds. In other words, they have typically managed to make their clients enough money to earn a comfortable living from their commissions. This bodes well for you, the investor, as you want to do business with an investment advisor who has the experience and the savoir-faire to make you money. It is also worth noting that the brokers who are still left standing after a sustained bear market (like the 1,000-day bear that technically ended October 09, 2002) have typically developed enough insight to pick viable investment opportunities from the wreckage of an oversold market.
  
  

• Investment advisors can often offer their clients a chance to participate in IPOs that are being underwritten by their brokerage houses. The near-term upside for most IPOs in a healthy marketplace is statistically very good as there is usually pent-up 'after market' buying interest in such issues. Conversely, discount brokers are not known for offering their clients such opportunities.
  
  

• Full service brokers are able to offer clients investment advice that is backed up by the extensive research resources of their respective investment firms. When trading through discount brokers, it is usually up to you, the investor, to do your own research. And it's unlikely that you will do as thorough a job as a professional research analyst.
  
  

• Competent investment advisors are typically adept at financial planning. In other words, they will build you a portfolio of investments that are suited to your needs as an investor. Typically, this involves diversification aimed at reducing the risk of holding more aggressive investments. And diversification typically means holding a variety of investments that do not move in tandem in response to different market conditions. For example, a mix of blue chip stocks, bonds, emerging growth and venture capital equities will broadly spread the risk of investing, while also offering exposure to a wide range of opportunities. Most investors do not have the sophistication and objectivity to build a balanced portfolio. Instead, they tend to act impulsively and emotionally and all too often 'put all their eggs in one basket.
  
  

• Once again, your broker should be a seasoned professional who offers objectivity in helping you make investment decisions. For instance, he or she should be there to counsel you as to when to cut your losses and when to take your profits off the table. Frequently investors allow their egos to get involved in making their own investment decisions. They won't cut loose a losing stock because they don't want to admit to defeat. There's always the hope that the stock will bounce back even when it keeps sinking lower. And they won't sell when they are riding a clear winner because greed sets in and they want to sell at the very top. But if you miss the top, as most people do, then it's often hard to find buyers as the share price heads back down. Conversely, the employees of discount brokers cannot legally offer you any advise as to whether you are making sound investment decisions. This could prove very costly in a volatile market where investors' raw emotions often cause them to act impulsively.
  
  

• In a heated market, it's often hard to get confirmation of trades when dealing with a discount broker. In the high tech meltdown of early 2001, countless investors complained that the phone lines of discount firms were clogged for long durations. So, they could not find out if they had sold their stocks at the requested prices. If they hadn't, many of them were forced to sell at much lower prices when they eventually found out that they had missed out earlier on their limit orders. Furthermore, the employees of discount brokers are merely salaried order takers. They get paid as per usual regardless of whether they get you good buy or sell executions. They have nothing to lose if you lose and visa versa.