How a Stockbroker Sees You

Let’s zoom into closer focus to see how commission system impacts you, as an individual.  This is where we get into the real nitty-gritty of how commissions are earned and split.

Flash back to the very beginning of your story, where you found yourself in the chair across the desk from your newfound best friend . . . your prospective broker. You’ve been provided with a cup of coffee, traded a few witticisms (of course, he laughed at each of your jokes), and by now you feel comfortable telling him your life story, including all your financial secrets.

As you talk, he is sizing you up. Will you be a difficult client to handle? Will you follow his recommendations without too much debate? Will you panic at every fluctuation in the market? These are important matters to him; time is money, and wasting it on a reluctant client means less time available to spend more profitably on the easily led. But even more important, there is now a dollar sign placed on your forehead that only he can see. His questions may sound casual, but his intent is anything but.

How much do you bring to the party? Five thousand? Peanuts. Ten, twenty, thirty thousand? Better, but still minor league. There must be more, he coaxes; and you find yourself wanting to . . . well, to qualify.

How about transferable 401(k) accounts, or self-directed pension funds? What’s already in your stock portfolio? He shakes his head, almost sadly: you’ll be far better off divesting those . . . well, he doesn’t come out and call them “dogs,” but the implication is clear.  Of course, he’ll receive a commission on any buys and sells you “need” to make. Are we into the six-figure level yet? The higher the total, the more attention you (and your money) will get.

Here’s a fact that may surprise you: almost certainly, he already knows what investments he is going to recommend to you—no matter what you may have to say. In many languages, words are read from right to left on the written page; not by coincidence, that’s exactly the way most brokers read when fresh meat is seated in the chair across from them.  That’s because they’re looking at a list of available investments the brokerage has compiled. The left column provides details about the investment, which is of secondary importance to any broker.  But it’s the right-hand column that is important to him, because that lists the commissions he will earn—if his new client takes the hook.

It is the fact that most investments are sold with several ways of paying for them.  For instance, some investment vehicles pay brokers commission annually, as long as the money stays on their books. Others pay on a basis the industry calls “front-loaded,” that is, the commission is paid to the broker immediately upon sale. Typically, the trade-off comes in a longer surrender-charge period: if you want to sell the investment before the end of that period, you pay a penalty—often, a significant amount.

The reason, of course, is that the up-front commission—designed to motivate the broker to sell the investment to you, since he gets a larger immediate payment—has to come from somebody’s pocket.  Since the issuing company has carefully calculated what it can earn from the money you invested—and how long it will take to make a profit—it protects itself at your expense by the longer surrender charge period.