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What is a Broker?

A broker is a financial intermediary in an exchange of money for a product or a service.

Brokers are commonly intermediaries for market investors, for example, in stock market trading. These are different from brokers in the real estate market, who are licensed real estate specialists who assist sellers, and some buyers, in home or property sales.

For the purposes of this article, we'll take a deep dive into the Wall Street breed of broker, and see how brokers impact your investment portfolio.

What Do You Need To Know About Brokers?

Historically, stockbrokers worked exclusively for the well-heeled, executing trades and managing affluent clients' money, with little regard for the investment needs of Main Street Americans. The digital age has changed all that, and now brokers are available for a wide array of investors, as the price of executing a securities trades has lowered.

Essentially, a broker executes a market trade in exchange for a fee or commission. Historically, those fees have been high, as traditional stock brokerage firms had few competitors.

For instance, the price to execute a complex trade in the late 1980s would have typically cost many times the rates available today, which can be as low as $5. Currently, broker fees are lowest for single-security, commonly traded stocks, where companies like TradeKing and Charles Schwab routinely charge as low as $4.95 when trading securities online.

Brokers usually charge more for more fund, option and commodities trades (often up to $20 per trade), but even so, today's broker prices are significantly less than they were just a few decades ago. That's due primarily to the ascent of internet-based trading.

What Does a Broker Do?

Securities can be traded on financial markets like the New York Stock Exchange and Nasdaq, or overseas on various exchanges like the London Stock Exchange or the Tokyo Stock Exchange.

While those markets are much easier to access these days, investors still need a broker to act as the "middleman" in a buyer and seller trade, and that's exactly what stockbrokers do.

How brokers handle securities trades can vary. Some trades are executed by discount brokerage firms electronically but many are also handled by flesh-and-blood brokers in direct contact with usually more affluent and more trade-frequent customers.

In that regard, brokers go well beyond the standard intermediary role, and often advise clients on what stocks to buy and sell, when is the best time to buy or sell, what the risks are in trading specific securities, and help investors understand how adding or subtracting securities can impact their investment portfolio.

Steps in the Broker Process

When brokers do step in and execute a trade for a customer, here are the steps involved in completing the process, using a purchase of 100 shares of ABC Co. as an example.

Step 1: Open an account

You open an account with your brokerage firm. Similar to opening a bank account, you provide your name, contact information, bank account number, and decide how much money you want to place in your account.

When opening your account, you decide how to funds, either opting to transmit money from your bank account electronically or sending a check. Once the money clears your bank account and hits your brokerage account, you're ready to trade stocks, bonds, funds, and other securities.

Step 2: Place an order

You place an order to buy 100 shares of ABC Co. stock at market price (i.e., the price the stock is selling for at the time of the market order.) You can also place a limit order, which directs the broker to buy the stock at a specified price, but there's no guarantee that price level will be reached, and your stock purchase may never get executed, as a result.

Step 3: Trade executed by broker

The trade is pretty much out of your hands now, and into the hands of your broker. He or she directs the trade down to the market trading floor to be executed.

Step 4: Floor trader involvement

A floor trader specializing in your stock is notified of your trade request and immediately scans the market for a seller of ABC Co. stock. A seller is commonly found in minutes, as floor traders know exactly where to go to find a seller of the stock.

Step 5: Stock is paired

A seller is found and your stock is paired up and executed at a specific price. The floor trader transmits the date, time and sale of the price, and sends it to your broker, who issues a "trade confirm" in your name, noting the security purchased (ABC Co.), the date and time of the sale, the price of the sale, and the fee the broker collects for having the trade executed.

Step 6: Stock is owned

While you now officially own 100 shares of ABC Co. stock, the security still needs to clear, noting you as the new owner, a process that takes up to three business days.

When the trade officially occurs, it will appear in your brokerage account as being owned by you, with an "as of" date. In the three days immediately after the trade, your shares of stock will appear in your brokerage account as "pending" until it clears.

Tips on Working with a Broker

Working with a broker gets easier after every trade you execute.

They handle the dirty work, find the securities for you, buy the security for you, and keep the security stored safely for you, and handle the back-office bookkeeping after the security appears on your account (or leaves it after you sell the security).

Still, there are some savvy moves you can make to best work with a broker, and save some money and improve your investment portfolio at the same time:

1. Lay the groundwork

Prepare ahead of time and see what type of broker works best for you -- a discount broker, who'll do less for you, but deliver a lower fee or commission, or a full-service broker, who'll provide a larger menu of services for you, but charge a higher commission.

If you're a hands-on investor and conduct your own research, you may not need the full-service broker. In contrast, if you're inexperienced in the ways of Wall Street and need the help, a few extra dollars paid to a broker are likely well worth the cost.

2. Meet multiple brokers

Don't stop and sign on with the first broker you contact. As with any service professional, like an insurance agent or a plumber, shop around and talk to five or six brokers and see which one best fits your investment needs. Check fees and commissions, ask about specific services like investment advice and portfolio management abilities, and find a comfort a level with a broker you trust.

Make that process easier by talking to friends and family, checking online brokerage company review sites, and asking brokers you're considering working with for references. 

3. Figure out your strategy

While your broker will have multiple investment strategies to deploy based on the situation, it's a good idea to ask him about his overall investment strategy. Ask how he builds an ideal portfolio. Ask how much risk he can take in managing client portfolios. Above all, ask brokers about their criteria for recommending a stock, bond or fund, and what that means for you.

4. Avoid brokers who recommend high commission securities

Be wary of brokers who regularly push stocks and funds with high commission rates, or try to steer you toward complex securities like options, commodities and futures that come with higher fees. Your broker should always have your best interest in mind -- not hers.

Consequently, if you're being pestered by a broker about a security you're not comfortable with and not happy about buying, let her know that this behavior is a deal breaker.

5. Ask for a commission schedule

Your broker should have a commission schedule that lays out general fee and commission structures for stock, bond and fund categories, so you'll know how much you'll be charged when you buy or sell a security.

In addition, look into paying an annual lump-sum commission with your broker. By paying an annual fee, you can steer clear of brokers who trade often and trade unnecessarily (a process known as "churning").

6. Check the fine print

Don't sign any contact with a broker that you don't understand, or have questions about. Read the contract thoroughly and ask the broker straightaway about any issues you're not sure about.

If you're in over your head, take it to a lawyer specializing in contracts. That should help you sleep better at night, knowing you have the contract with a broker that puts your best interest ahead of anything else.