10 Questions to Ask Your Broker

The broker works for you, so arm yourself with as much information as you can before you choose one.
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Editor's note: This is a special excerpt from TheStreet.com Ratings' Ultimate Guided Tour of Stock Investing. Other Beginner's Guides cover stock basics, market indices, diversification, financial goals, risk tolerance and growth and income stocks .

Although your broker is supposed to be working on your behalf, there is an inherent flaw in the

brokerage system: The bulk of a broker's compensation comes from the

commissions he generates. So the more he gets you to buy, the more money he makes. While most

brokers simply try to make a decent, honest living, the system inevitably rewards those who are aggressively looking out for the interests of the firm while penalizing those who prioritize the interests of the customer.

Your best defense is to arm yourself with as much information as you can when choosing and dealing with a broker. To that end, here are 10 questions you should ask. Keep in mind though, that unless you ask these questions specifically, your broker will probably never tell you.

Question #1: What investment training have you had?

You're likely to hear your broker hem and haw over this answer. The answer you want to hear is that your broker has formal training, such as a degree in finance or accounting, or at the minimum a comprehensive training program at his firm. Most brokers are primarily salespeople, and many have not had any financial training aside from how to sell the firm's products.

The Great Debate: Brokers vs. Advisors

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The brokerage firms do make an effort to weed out truly inept individuals. But again, the system works against them. They need bodies to generate commissions, and after investing time and money to train salespeople, they're likely to err on the side of keeping as many as possible, including the borderline and marginal.

Question #2: Do you receive extra commissions for selling house products?

For years, brokers were given free trips, expensive gifts and just extra money to sell "in-house"

mutual funds to their clients.

And despite regulators' best efforts to crack down on this practice, it still continues. So, be sure to ask your broker to give you the performance history of the product he's pushing. Then go to

TheStreet.com Ratings Mutual Fund Screener

for an evaluation of the fund's risk-adjusted performance.

Question #3: Is your firm underwriting this issue?

Most firms, even the smaller regional ones, have some

investment banking business. In other words, they help companies sell their stock to the public for a fee, through an initial public offering (

IPO), for example. There's nothing wrong with this since it's simply the manner in which companies raise


The problem arises when brokers are asked to support the investment banking side of the business by hyping those same stocks to their customers, an obvious conflict of interest. The stocks are rarely worth the hype, and often get dumped on the public with disastrous results.

So, you need to find out if the firm is

underwriting any of the stock offerings for the company it's recommending.

Question #4: Do your research analysts cover some of the same companies that the firm underwrites?

Brokerage firms are supposed to maintain a "Chinese Wall," which clearly separates their research departments from their underwriting departments. It is illegal for these departments to know what the other is doing before the information becomes public. However, in reality, the Chinese Wall is easily penetrated. It is not uncommon for research

analysts to be forced to write a glowing report on a company that their brokerage firm is taking public, or to suppress a negative research report which the firm fears could hurt its underwriting business.

Furthermore, those same research analysts are under pressure to promote these companies to their retail brokers, who, in turn, are under pressure to sell them to their brokerage clients. Investment banking firms are required to perform what is called "due diligence" -- a serious and comprehensive review of a company -- before they decide to underwrite its stock. But they are also under tremendous pressure to bring in big underwriting fees. Consequently, sometimes their due diligence is not so diligent.

Question #5: Do you have a quota to meet for selling the stock in the companies that your firm underwrites?

Brokerage firms typically assist their underwriting clients with "dog and pony shows." This is where the investment bankers -- and often the research analysts as well -- hold special meetings for the firm's brokers or visit the branch offices of the brokerage firm to hawk the new stock. There is tremendous pressure on the brokers to sell these stocks to their clients. Many are even required to sell a certain quota of shares. Ask your broker about this. You won't get an honest answer every time, but it can't hurt to try.

Question #6: Does your firm have its own trading account?

Most firms trade stocks for themselves as well as for their clients. You can tell if a brokerage firm has a trading account by looking at its

income statement, so don't be bashful about asking for a copy of the statement. You won't be able to tell which stocks are in the firm's trading account, though, which leads to the next question.

Question #7: Do you currently hold this stock in your firm's principal trading account?

If your broker is honest, he'll tell you the truth. And if you find out the firm does hold the stock in its trading account, you should probably decline the broker's advice, or at a minimum, get a second opinion from another source. Chances are the firm is just trying to clean out its own

portfolio of stocks that haven't done well for them.

Question #8: Are you selling this stock on behalf of one of your major clients? If so, why is he selling and how many shares is he selling?

Sometimes, a major customer of a brokerage firm wants to unload a sizable holding of a losing stock. And because he is a very good customer of the firm -- generating a lot of commissions -- the firm is going to try to accommodate him. But they have to find buyers for that stock, so they try to push it on their smaller customers who may not know that the stock is a loser. It helps to know how much of this stock is on the block, who is selling it, and why.

Question #9 (when buying through a bank or Savings & Loan): Is this investment insured by the FDIC?


bonds and mutual funds are not federally insured for market losses. The Securities Investors Protection Corporation (SIPC) insures investments only if a company goes out of business, and even then, you only get the current

market value. But when stock or mutual funds are sold through a bank, investors are sometimes led to believe that these investments do fall under the FDIC guarantee.

Many bank customers think that whatever they buy at the bank is covered by the same FDIC insurance coverage. And unfortunately many mutual funds don't make an adequate effort to dissuade customers of this notion.

Question #10: What about Dividend Reinvestment Plans (DRIPS)? Wouldn't I save a lot of money buying stocks this way?

The correct answer is "Yes." Unfortunately, many brokers will never tell you about it. Some may even try to discourage you by saying you have to wait too long to actually buy the shares, or that you can't get them at the price you want. Reason: There are no commissions in it for them.

The truth is that

DRIPS can be very profitable investments for many people. About 1,100 companies traded on U.S. stock exchanges have DRIPS. After you buy the initial

share, you can then buy additional shares right through the company or its agent. This can save you a ton of money in commissions. Sometimes you are charged a small fee; other times the plan allows you to buy shares at no fee whatsoever. In either event, the savings are significant. You can even set up many of these plans for automatic transfer from your bank account. Your dividends are automatically reinvested.

There is a downside, though. You can't specify at what price you want to buy the shares because your money is pooled with that of other investors, and the company buys shares on a regular schedule. But if you're investing for the long term, you shouldn't be overly concerned about

market timing.

This article was written by a staff member of TheStreet.com Ratings.