Oct 23

Investment: Not All Stockbrokers Are Your Friend

by Stacia Dahl

This question came to Montana’s AARP office from Jack in Billings.

Q: I recently found out that my stock broker put all of my investments into variable annuities. As it turns out, variable annuities are considered “inappropriate investments” for someone my age (I just turned 60) but he put me into that type of investment because he makes a lot more in commission. How can I protect myself from an unscrupulous stock broker in the future?

A: Jack, if you knew that your stock broker earned substantially more commissions from certain investment choices, would you be less likely to trust his advice?

That’s a sobering thought, isn’t it? The vast majority of stock brokers – even the ones you pay fees to – don’t owe you, the individual investor, much loyalty at all. As a result, they are free to recommend risky, high-fee investments that might cost you more money and earn themselves higher commissions.

In May, AARP conducted a survey asking people who invest in an employee retirement plan whether this conflict of interest mattered to them.

The numbers were overwhelming. Nearly eight out of 10 said they were at least “somewhat concerned” about this potential conflict. A staggering 93 percent of those surveyed said they think any advice given by a stock broker should be required to be in their best interest.

Yet, as the rules stand today, most stock brokers are free to put their interests first, without even letting you know they’re actually looking out for “Number One.”

Part of the problem for consumers is that there is no fundamental “duty of care” standard that applies to all stock brokers and all clients. It varies. People advising workplace investors – for example, 401(k) and 403(b) investors – may owe one type of duty, while people advising individual investors (IRA and mutual fund investors) owe another duty, depending on what type of credentials they carry and what kind of investments they sell.

There are, however, some advisors who owe a clear duty of loyalty – a “fiduciary duty” – to their clients. They are called “registered investment advisors” (because they are either registered with the U.S. Securities & Exchange Commission or a state securities regulator), and they operate on a fee-for-service basis. In other words, you pay them some percentage of your managed assets and, in return, these advisors are obligated to put your interests ahead of their own.

Stock brokers sell products for commissions and the law requires them to make recommendations that are suitable for you based on your investment objectives, your level of risk tolerance, your financial situation, among other factors. Stock brokers are not required to act in your best interest. So, while a broker may recommend to you a suitable fund, stock, or other financial product, they are not prohibited from recommending an investment that will result in a bigger commission for them and a higher cost for you.

Investment advisers manage your money for a fee, usually about 1% annually based on the size of your investment portfolio. They do not sell products for a commission. Investment advisers have a fiduciary duty (a legal requirement) to act in your best interest and are, therefore, prohibited from taking unfair advantage of your trust.

When you enter an arrangement with an investment firm, the agreement you sign should tell you the capacity your financial adviser is acting in and whether the advisor is held to a suitability standard or a fiduciary standard.

Federal regulators, such as the U.S. Department of Labor and the SEC, are trying to clear the muddy waters by imposing that gold standard – the “fiduciary duty” – on all advisors, with no loopholes.

Naturally, the mutual fund industry – which manages and invests nearly $20 trillion of Americans’ retirement assets – is pushing back — with some success.

So now what? If the government can’t protect you from unscrupulous brokers, what can you do to protect yourself? Jean Setzfand, vice president of the Financial Security team in the Education and Outreach group at AARP offers these tips:

  • First, ask your broker whether he or she is a fiduciary.
  • If they are not a fiduciary, ask your broker about the fees associated with the investment he’s recommending, and how those fees compare to other investments. Ask whether he or she will earn a commission if you choose the investment.
  • If they are a fiduciary, you may be paying a management fee in addition to fees charged by the investment funds you select. Over the course of time, those fees will eat up some of your account balance. Unless your broker is consistently beating the market by at least as much as you are paying in fees, you are wasting money – perhaps lots of it.
  • If you don’t want to choose between conflicted brokers or high fees, consider investing in index funds through an online brokerage. Index funds automatically invest in broad swaths of the market – for instance, the Dow Jones Industrial Average. They make money when the market is up, and lose money when the market is down. But, because they don’t have to pay a superstar fund manager to pick stocks for the fund, their fees tend to be much, much lower than actively managed funds.
  • In Montana, you may call the Commissioner of Securities and Insurance at 1-800-332-6148 to make sure your investment advisor is properly licensed and the product is properly registered.

Do you have a question for AARP Montana? Send your question to “Ask AARP Montana” at MTAARP@aarp.org or 30 W 14th St., Helena, MT 59601 or call our toll-free hotline at 866-295-7278. As we receive questions, we will consult with both internal and external experts to provide timely and valuable advice.

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