There is nothing wrong with using a stock broker sometimes. Many provide valuable advice and insights that can help you achieve your ultimate financial goals. But there are three mistakes many investors make that most brokers won’t point out. That’s because those errors put big bucks in their pockets. Here are the pitfalls you want to avoid:
1. No Clarity on How Brokers Work
Stock brokers are financial advisors (of sorts) but not all financial advisors are stock brokers. In fact, there are three different kinds of financial advisors. They all work differently because they are all licensed and compensated differently. While you might need a stock broker, you might do far better by not hiring one. There are many situations in which you could save a great deal of money by hiring a specialist (like a CPA or attorney, for example) to give you specific advice on a financial problem you are facing, and then just use a service like Betterment.com to invest your assets for you.
Stock brokers love it when you don’t understand how different financial advisors work. Don’t let that mistake cost you a fortune.
2. Not Knowing When To Avoid Taking Risks
How much risk should you take? This comes to play when you work with brokers, because they are compensated by commissions. They just love it when you buy and sell. And the best way to get you to execute transactions is to convince you to buy this stock or that mutual fund. But sometimes you’re better off to hold on to your existing investments or to keep your money in the bank, rather than make changes all the time. If you have short-term financial needs, for example, you should not invest in anything other than the bank.
Let’s say you are planning to buy a home next year and you are wondering what to do with the $50,000 you’ve saved for the down payment. You don’t need the money for 12 months. So you ask your stock broker what to do with that cash. The last thing she’ll tell you to do is to leave the money in the bank, but that’s the best advice for your particular situation. Why?
Because you can’t afford to take any risk with that money. As a result, the bank is the best alternative even though the interest you’ll get is ridiculously low. Your stock broker won’t give you that advice because if she does, she won’t make any money. This is another example of how you and your stock broker are at odds at times. Bottom line? Don’t allow a broker to convince you to invest money you have no business investing.
3. Being Unaware of Lower-cost Alternatives
The least-cost alternative is not always the best investment choice. But I do believe you should be aware of all the investment alternatives, including index funds and ETFs, before you make an investment decision. If you are a “buy and hold” investor, you are shooting yourself in the foot if you ignore these investments. And even if you are a performance-based investor, these investments will have a place in your portfolio at one time or another.
Commissioned-based brokers will go broke if they let you know about these investments, let alone encourage you to take advantage of them.
There is nothing wrong with paying someone in exchange for valuable advice. Brokers can provide insight into the market. But there are times when helping you puts the broker in conflict with helping herself. In those circumstances, you need to be aware of the situation and make sure you put your own interests first.
Neal Frankle is a certified financial planner in Los Angeles and an authority blogger at WealthPilgrim.com.