It is estimated that more than 42 million Americans from virtually all walks of life own shares in America’s businesses. A New York Stock Exchange survey shows that about 40% of those had incomes under $25,000 a year.
Investing in the stock market is a complex business. In many instances the assistance of a good stockbroker or other financial specialist is an essential element of achieving success in the stock market.
The purpose of this Alert is to provide some tips on how to choose and deal with a stockbroker, also known as a registered representative or account executive. There are many things you can do to greatly increase your chances of establishing and maintaining a good relationship with a stockbroker, which in turn will increase the likelihood of your realizing your ultimate investment goals.
Setting Your Investment Goals
Before you even begin the process of selecting a brokerage firm and individual stockbroker you should determine your realistic investment needs and objectives. Are you primarily interested in long-term growth, a steady income stream, tax savings, quick profits or some combination thereof? Your personal financial situation is your best guide to choosing an investment. If you have good income, or if you are relatively young and feel you are able to take more investment risks for larger gains down the road, “growth” through appreciation of capital might be your choice. Conversely, if you are living on a fixed or retirement income, your main goal might be regular income through dividends and interest while at the same time protecting your principal.
There are various books and financial publications that you may obtain in the business section of your library that may help you in developing your investment strategy. Many schools and community colleges offer low cost courses on the basics of personal investing, which also may be helpful in sorting out your own investment goals and strategies.
Be realistic in setting your investment goals. Remember that no investment is risk-free and, as a general rule, the greater the hoped-for return the riskier the investment. Other questions to ask yourself are whether you can afford to lose the money you plan to invest, whether you have adequate life insurance and whether you have sufficient cash reserves in a very safe place, such as a federally insured savings account, which can be reached rapidly in case of a personal emergency. Even if you have substantial assets, it does not necessarily mean that every investment will be appropriate for you. You should make only investments you fully understand and are comfortable with.
It is also important to realize that, once you have decided on your investment objectives, you have another task in selecting those you want to help you reach your financial goals. You may wish to consult with an accountant or someone familiar with your financial status to help you in determining your financial objectives. Bank trust departments and investment advisers should also be considered, depending on how much money you have to invest. As a general rule you will pay a fee for such services in addition to normal brokerage commissions.
Choosing Your Broker
When you decide to use a stockbroker you need first to consider whether you want a full service or a discount broker. The primary advantage of a discount broker is that commissions are usually lower than those charged by a full service firm. In fact, the employees of discount brokers are generally paid a straight salary unlike the full service broker, who is paid commissions based on the number and size of transactions made in your account. Generally, only full service brokers will recommend specific stocks or investment strategies that are intended to suit your financial situation.
You should take the same care in picking your broker and sales representative (also known as stockbroker) that you would take in selecting the services of any other professional. The first thing to realize is that brokerage services are highly personal and the quality of the service you receive will depend not only on the firm that you decide to do business with, but also on the particular sales representative you choose. A good way to start your search is to ask for recommendations from friends you know to be successful investors, business colleagues, your lawyer, accountant, banker or other professional whom you may trust. Keep in mind, however, that someone else’s ideal broker may not be right for you. Others may have different financial situations, needs, objectives, temperaments and investment philosophies than you. Your goal should be to find a broker who will be able to understand and accommodate your particular investment status and personality.
When you have made your decision as to one or more brokers that you may wish to deal with, you can start off by asking each broker for a brochure that describes the investment options offered by the firm, a list of the services provided, copies of the firm’s specific recommendations over the past year, and a copy of the firm’s commission rates. As to commissions, although firms have commission schedules based upon the number of shares sold and the price per share, since 1975 firms have been free to set their own commission schedules. Active investors may be able to negotiate lower than standard rates.
When you first go to a broker’s office, you may wish to meet with the office manager to discuss your investment goals. He or she may be able to steer you to a broker particularly knowledgeable in your areas of interest. When you meet with a particular broker at the firm, treat the occasion as an interview. Don’t be intimidated by an impressive office or a fast-paced, smooth, but superficial sales pitch. Discuss your investment objectives, and financial capabilities fully with the broker. Ask questions and really listen to the answers you get. Remember there are no dumb or silly questions when it comes to understanding how your hard earned money is going to be invested.
Make sure that the firm’s products, services, recommendations and commission structure are compatible with your investment goals and that you are confident that the particular broker you have chosen will help you meet those goals.
Find out whether the brokerage firm is a member of any national stock exchange or of the NASD (National Association of Securities Dealers) and SIPC (Securities Investors Protection Corporation). The NASD is a national self-regulatory organization whose membership includes almost all of the broker-dealers in the United States. SIPC is a quasi-governmental entity created by act of Congress to insure the cash and securities of SIPC members’ customers in case a member goes into bankruptcy. SIPC protection is limited to $500,000 per customer, with a further limit of $100,000 of cash equivalents per customer. SIPC does not insure the outcome of any given investment. It only protects investments from being jeopardized by financial difficulties which SIPC members may experience. It cannot and does not protect you from losses resulting from bad investment advice, unintentional or otherwise.
Before you deal with any broker’s office, you may also wish to contact your state securities commission and/or your local Better Business Bureau to verify that the firm and broker are duly licensed to do business in your state and to learn whether or not the firm and broker have been disciplined by any government regulatory agency.
The Relationship-The New Account
Once you have decided on a particular broker, you will have to assist him in filling out a new account form, which is used to ascertain and establish certain facts relative to you as a customer. Among other things, you may be asked questions about your net worth, annual income, investment objectives, risk tolerance, tax bracket, where you work and the depth of your investment experience. Do not take this line of inquiry as an unnecessary intrusion into your private affairs. Depending on the circumstances the broker may be required by the various stock exchanges and the National Association of Securities Dealers to use “due diligence” in the opening and handling of the customer accounts. The broker is required to “know the customer.” This is an ongoing requirement which you should help your broker meet by continually updating him or her whenever you experience a significant change in your financial situation or investment goals. The more your broker knows about you, the better able he or she will be to make appropriate investment recommendations to you. Filling out the account form can provide an invaluable chance to discuss your needs and objectives in detail. The information you disclose is required to be kept confidential from everyone except various government agencies or other parties pursuant to a subpoena.
There will be still more forms to fill out if you want to borrow money from the broker at a predetermined interest rate to buy securities (buy on margin) or if you want to trade options or commodities. Such activity requires setting up separate accounts with special requirements. This is so because of unique suitability requirements and risk factors attendant to this specialized activity. Do not open any of these accounts unless you clearly understand how each operates and appreciate the risks involved.
Another type of account is the discretionary account in which you give the broker complete authority to act without your permission. Discretionary accounts may be useful to some investors. However, because a discretionary account may be open to significant abuse by the broker, who receives commissions based on transactions in the account, many firms refuse to accept discretionary power over an account or, at least, limit such accounts to their most senior sales personnel. While full discretionary authorization must be given in writing, it is possible to orally grant an account executive limited discretion as to the best time and price at which to buy or sell a specific security. Always use caution in giving oral authority to trade.
Sources of Information
Because someone is professionally successful, has status in his or her community and earns a good living does not automatically mean they will be a successful investor. Achievement in one field does not necessarily translate into investment wisdom. Any investor, regardless of his station in life, should consider each investment alternative on his own and in consultation with his broker. A wise investor is an informed investor. This is especially true in light of the numerous and complex financial instruments being offered today.
Apply some effort to clearly understand what each investment is, how it is structured, what its inherent risks and benefits are, and whether it fits into your investment strategy. For many investors, a diversified investment portfolio may be the preferred investment strategy.
One source of information will be the firm and the individual broker. The firm will usually have several regular publications available from its research department to keep you up to date on market trends, good investment possibilities and other relevant financial information. Other materials available to you may cover topics ranging from investment basics to advanced market analysis.
When a broker recommends a security, he or she should do so on the basis of sound reasoning and have something more than a “hunch” or a “tip” to back it up. A recommendation should be made only when the broker has reasonable grounds to believe the investment is suitable in view of the customer’s investment objectives, financial situation and needs, level of knowledge, and degree of sophistication. All this takes analysis — of both the security and the customer. Ask your broker to provide you with copies of the research or other materials used as a basis for recommending a specific security.
Good communication between you and your broker is essential for a profitable and continuing relationship. The kind of service — and the amount — depends on what you and the broker have established at the time you open your account. Essentially, the frequency with which your broker calls should be consistent with your investment objectives and the size of your portfolio.
For instance, if you hold a total of five stocks which are invested for long-term conservative growth, you probably will not need to talk to your broker more than once or twice a year, if that often. On the other hand, a larger account of 20 or 30 growth or speculative stocks requires closer supervision, and in this case a vigilant broker may want to call you several times a week. You may ask your broker to call you periodically, if you wish, for maintenance of your account, but there is no definite standard that applies to every account.
You will want to know as much as you can about any company in whose stock you are interested. Likewise, if you already own shares in a company it is smart to keep up with its current share price and any other developments relevant to its market performance. You can find valuable information about companies from their annual reports, which are available for the asking even if you are not a stockholder. Your broker can also get copies of annual reports for you. The reports usually contain a statement of the company’s earnings, its view of its past performance and prospects, as well as a discussion of new products and the status of industrial relations.
Many newspapers carry business and stock market information each day. The business or financial sections of many daily papers carry stock tables that report daily price changes and other information, including yields, price/earnings ratios, and profiles of price movements about stocks listed on major exchanges and over-the-counter markets. They also report news about the corporate and financial world that may interest you and be relevant to investment decisions.
There are also numerous business periodicals and financial services to which you may subscribe or that are available to you in your local library, which contain reports on companies, make stock recommendations, feature articles on trends in different industries, the economy and the stock market in general. Only after you have evaluated all the investment information available should you decide whether or not to buy a security.
If You Have a Problem With Your Account
Most dealings between customers and brokerage firms are straightforward and trouble free. Provided the investment was appropriate for you, was presented to you fairly, and entered into by you with full knowledge of the risks involved, you can’t blame your broker if it’s not a successful as you might like. In some instances, your expectations may have been excessive and unrealistic.
Sometimes, however, problems between brokers and customers do arise. Some can be considered of an operational nature, such as the late delivery of a stock certificate or dividend check, and often may be resolved by dealing directly with the firm. Other problems are potentially more serious. They may involve sales practices where you may, in essence, have lost control of your account and the objectives and goals that you have set. Among the more severe problems are excessive trading in your account (churning), unauthorized trading, unsuitable recommendations, and failure to execute trades or deliver securities.
Be sure that nothing happens in your account without your prior authorization, or that represents a deviation from your investment strategy. If there is anything that you do not understand or that is inconsistent with your intentions, bring the matter up with your broker immediately. Remember the broker is there to service your account.
If the broker sends you confirmations of stock trades you don’t recall agreeing to, call him immediately. Erroneous trades usually can be straightened out without much difficulty if they are caught in time. If, however, you wait to see if stock mistakenly bought goes up and only try to cancel the trade when the shares perform poorly, your delay can be used as evidence that you acquiesced in the trade. In addition, make the effort to read and understand the monthly or quarterly account statement that you receive from the firm. Assure yourself that these statements are in agreement with your confirmations. If there is any inconsistency between the two, notify the firm immediately.
If you have any of these problems or any other identifiable problem, or something just doesn’t seem right about the way your account is being handled, you should, as stated above, discuss the situation immediately with your broker and, if necessary, with the office manager. If you still do not get a satisfactory response, notify your state securities commission. At the same time, you may wish to send a letter detailing your problem to the chief compliance officer of the broker’s firm at the firm’s home office. You can get the compliance department’s address from your broker, his office manager, or your state securities commission.
Other agencies or organizations that may be able to help you are the regional offices of the United States Securities and Exchange Commission, the National Association of Securities Dealers, or, if it is a problem involving the purchase or sale of commodities, the National Futures Association and the Commodity Futures Trading Commission. The New York Stock Exchange, the American Stock Exchange, or any exchange that lists your stock can investigate complaints if they involve a member firm. Your state securities commission has the addresses of all these organizations.
Arbitration
If you don’t achieve an acceptable resolution through these channels, you may wish to consider initiating an arbitration claim or legal action. Arbitration is a method of having a dispute between two or more parties resolved by impartial persons who are knowledgeable in the area of controversy. Arbitration offers a less costly and generally faster means of resolving a claim than traditional litigation. It is very important for you to realize, however, that arbitration awards are final. Arbitration decisions are subject to review by a court only on a very limited basis. By choosing arbitration as a means of resolving a dispute you effectively give up your right to pursue the matter through the courts.
Conclusion
Chances are that if you follow the suggestions contained in this alert, you won’t ever need to bring an arbitration or legal action. Take your time in selecting a broker and take the time to establish a relationship of mutual trust, respect, and understanding with your broker. Be an informed and aware investor. Keep on top of the activity in your account. Never hesitate to ask your broker a question and don’t be afraid to say “no” to a recommendation by your broker that is not compatible with your investment strategy. Understand the risks and benefits of every prospective investment before making a decision to buy or sell. Never buy on the basis of rumors or so-called hot tips. Keep your eyes open and act on fact rather than emotion.
Issued 1999
This publication was compiled by the North American Securities Administrators Association and the Better Business Bureau and is furnished to you by the Texas State Securities Board.
