Avoid Being Played in Wall Street’s Fee-Extraction Charade

Lowering Your Costs Means Better Returns

Many brokerages these days tout their low trading commissions. But don’t be fooled. Low advertised costs to trade stocks conceal the hidden fees brokers often extract from investors by not giving them the best execution price.

A Senate Permanent Subcommittee on Investigations recently held a hearing that exposed major brokerage firms’ practice of routing orders to exchanges that give the firms rebates. In almost all cases, the exchanges preferred by brokers were the ones that paid the biggest rebates, not the ones that gave clients the best execution. Such rebates are estimated to cost investors $5 billion per year.

It’s just one way individual investors are given short shrift. At the same time, the high-frequency traders and investment banks operating in off-exchange venues called “dark pools” get preferential pricing and the ability to manipulate markets for their own gain.

Sometimes rogue brokers will even manipulate securities prices in order to prevent their clients from profiting! Earlier this year, mega-bank Barclays was hit with a $44 million fine by European regulators after a trader manipulated the gold price fix in order to prevent a client from receiving gains on an option contract.

One simple way to avoid paying unnecessary “subsidies” to professional traders and trading firms is to minimize the quantity of trading you do. For a variety of reasons, most people do better holding core investments for long durations rather than trying to trade in and out of them. Remember, trading always benefits the brokerage industry and rarely benefits you.

Is it Time to Fire Your Broker?

If you’re currently working with a broker whom you suspect has guided you into poorly performing investments for the sake of boosting his commissions or engaging in other questionable practices, it may be time to fire him.

Why not try going it alone? You have nothing to lose but excess fees!

If you believe that you lack the experience to go it alone and/or value the services provided by a full-service broker, be very selective in choosing a new broker. Look for a broker with experience. Many brokers remain in the profession only a few years before moving on to other things. Someone who has been through bull markets, bear markets, and everything in between is less likely to be caught up in a temporary buying or selling frenzy or other investment “fads” that come and go.

Ask a prospective broker about his investment philosophy. How does he evaluate individual stocks? Does he help guide his clients to safety during bear markets, or does he passively sit by and wait for the market to turn around?

Ask a prospective broker how he is paid and whether there are any hidden commissions or kickbacks that could taint his recommendations. (If he says he doesn’t receive any sales commissions on any of the financial products he sells, he’s probably lying.)

Never deal with anyone whom you suspect of being the slightest bit crooked. If you’re not 100% comfortable with a broker, don’t give him your money! You can find out if a broker has been disciplined for violating securities laws by contacting FINRA, Financial Industry Regulatory Authority (301-590- 6500; www.finra.org/).

Key Leverage: How to Hold a
“Breaking Bad” Broker Accountable

Most complaints against brokers don’t wind up in court, but instead go into arbitration. This is because brokerage firms make you sign a contract which, in fine print, states that you agree to resolve disputes through arbitration. FINRA handles most investor-broker arbitration cases.

To win your case, generally you’ll need to prove that your broker had an undisclosed conflict of interest (i.e., he received under-the-table kickbacks), that he deliberately misled you, or that he was negligent in failing to inform you of the potential for loss in the investments he selected.

You may be able to recover damages for your investment losses and fees, and even a reasonable sum to account for what you could have made if your funds were invested appropriately. You may also request to be awarded attorney fees.

Even though going through arbitration is not the same thing as going to court, you’ll probably want an attorney by your side, as the broker most definitely will have one or more by his side. To locate a lawyer who specializes in arbitration disputes with the securities industry, contact the Public Investors Arbitration Bar Association (888-621-7484; www.piaba.org).

Steps to Switching Brokers Safely
in a Stacked System

Perhaps you’re tired of paying exorbitant commissions and fees with your current stock broker. Perhaps you’re feeling the pain from your broker’s bad advice.
Or perhaps you’re worried about your brokerage firm’s solvency amidst the volatile credit environment.

For one reason or another, you may be looking to switch brokers. The best way to do it is not to sell all your securities and cash out. Instead, you can initiate an electronic transfer of assets from one brokerage firm directly to another.

You’ll want to have your new account set up and (ideally) partially funded before you initiate the transfer. Unfortunately, the process can take six to ten business days, during which your transferred assets are in limbo and you’re unable to trade.

Get the ball rolling by filling out a transfer initiation form with your new firm. Errors or incomplete paperwork can delay the process, so get everything in order and double-checked for accuracy in advance of requesting the transfer to be processed.

One final note of caution: never do business with a brokerage firm that isn’t a member of the Securities Investor Protection Corporation (SIPC). Much like the FDIC insures against bank failures, the SIPC protects investors in the event that a brokerage firm goes out of business or defrauds its clients. Through the SIPC, you’ll likely be able to get your assets back. Without the SIPC, you’re taking a huge risk.

Construct a (Nearly) Complete
Commission-Free Investment Portfolio

If you mainly invest via mutual funds or exchangetraded funds, you’ll probably want to opt for a broker that offers a large selection of commissionfree funds.

Schwab offers 13 in-house commission-free ETFs tied to stock and bond indexes. No alternative asset classes are offered, although you can get an emer ging markets equity ETF.

Fidelity’s free ETF offerings are slightly broader than Schwab’s. Fidelity features commission-free iShares ETFs. Unfortunately, Fidelity omits iShares’ sector and alternative strategies funds, leaving investors to choose among conventional stock and bond categories (only a few of which are international).

Through Vanguard Brokerage, you can trade Vanguard-branded ETFs without paying commissions. Vanguard does offer a few sector ETFs (including ones in energy, utilities, and healthcare). But they are U.S.-only sector ETFs, which shortchange investors who want sector exposure that includes stocks from the most dynamic, fastestgrowing parts of the world.

TD Ameritrade now sports more than 100 commission-free ETFs. Disappointingly, there isn’t much in the way of sector ETFs among them, although several single-country ETFs are available for those who want to focus their international investments. Four commodity futures vehicles are available, but nothing precious-metals specific is.

The choices available within the category of commission-free ETFs are generally biased toward U.S. markets and conventional, broad-based indexing strategies. It is possible to largely construct a well-diversified portfolio using commission-free ETFs. But the most glaring omission in each of the firms I examined was the lack of any ETF tied to gold, silver, or the hard assets sector. Brokers and the firms they represent have a habit of trying to steer clients away from precious metals, so when it comes to building out that portion of your portfolio, you’re on your own.


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