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Do a Cost-Benefit Analysis

Brokers and investment advisors are expensive. Is the expense justified? The short answer is, it depends. Every case is different. There are a myriad factors that go into the analysis, including (1) the skill and ability of the broker or advisor, and (2) the goals, objectives, and financial sophistication of the investor. One thing is clear, however: high costs do not guaranty high risk-adjusted returns. For example, studies show that the majority of actively managed accounts underperform the market on a risk-adjusted basis once fees and transaction costs are taken into account. Based on the foregoing, it is imperative that investors undertake a cost-benefit analysis before making the decision to sign up with a broker or advisor. For some investors, the benefit of working with a broker or advisor is outweighed by the additional costs that accompany that relationship. For example, a “buy and hold” investor who has a fairly high-degree of financial sophistication might be better off opening a discount brokerage account and directing his own investments than he would be by hiring a broker or advisor. Although there are a growing number of investors taking that approach, the majority still rely on brokers and advisors for investment recommendations and advice. For those investors who have already ruled out self-directed investing, the cost-benefit analysis should involve a comparison of the relative costs and benefits of different brokers and advisors. In order to evaluate the potential benefits, the investor will need to obtain information about the broker’s or advisor’s performance history. If the broker or advisor cannot supply that information, that should tell the investor everything he needs to know about the broker or advisor.

Do Your Due Diligence

Due diligence efforts should go beyond merely checking performance history and costs. Investors should attempt to gather other information and opinions about the broker or advisor under consideration. One source of information is the Financial Industry Regulatory Authority (“FINRA”) BrokerCheck website. BrokerCheck contains a wealth of information about individual brokers, including disclosures relating to misconduct and incompetence. For example, BrokerCheck enables investors to see whether a particular broker has any prior judgments, arbitration awards, or complaints, or whether he or she has filed for bankruptcy protection. Investors can also obtain prior employment history from BrokerCheck. Investors should watch out for so-called “cockroach” brokers who move from firm to firm in quick succession. This can be an indicator of sales practice violations. A similar source of information to BrokerCheck is available with respect to investment advisors at the Investment Adviser Public Disclosure (IAPD) website. Another factor that investors should consider when evaluating a broker or advisor is training and education. Brokers and advisors are required to have certain securities licenses. In order to get those licenses, the brokers and advisors have to pass examinations. However, a passing grade simply indicates that the broker or advisor has the minimum knowledge and competence required to perform his licensed functions. In order to separate the wheat from the chaff, investors should consider factors like experience and whether the broker or advisor has any relevant degrees and/or reliable credentials, like the CFA or CFP designations.

Control Your Investment Profile

Every investor has a unique investment profile made up of his investment objectives, risk tolerance, investment time horizon, investment experience, and various other characteristics. Securities regulations require that brokers and advisors obtain this information from their customers and clients as part of the account opening process. The information is usually recorded on an investment profile form. In most cases, the broker fills out the form himself, or has an assistant fill it out. This approach can lead to problems because sometimes the information recorded on the form does not accurately reflect what was communicated to the broker or advisor. Sometimes, this is the result of an innocent mistake and sometimes it is not. In either situation, the inaccuracies can come back to haunt the investor. For example, imagine the situation where a customer meets with a broker and tells the broker that she is a conservative investor with a low risk tolerance, but, for whatever reason, the customer’s investment profile form is filled out incorrectly. Instead of stating that the customer is conservative, the form states that the customer wants aggressive growth, and is willing to speculate. When the form is presented to the customer to sign (along with a stack of other account opening documents), the customer may miss the mistake, or simply sign the form based on misplaced trust. If a dispute later develops about the suitability of the investment strategy employed in the customer’s account, the broker will point to the investment profile form to justify his actions. To avoid this situation, investors should insist on filling out the investment profile form themselves, with or without the assistance of the broker or advisor.

Need Assistance?

If you have suffered investment losses as a result of malpractice or misconduct our experienced team of investment fraud attorneys may be able to assist you in recovering some or all of your losses. Call us toll-free at 888-607-4819 for a free consultation or email us through our “Contact” page to schedule a free consultation.