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Selecting a Brokerage Firm

May 21, 2008  |  Difficulty: Easy

Dollars for investments
There are many different types of brokerage firms, and the cost for services will vary according to what they do for you. If you are an experienced investor, you may be able to choose the securities you want to buy or sell. It is a good idea to look at a discount brokerage firm that charges a minimal fee for doing a simple execution of the transactions that you have selected. Online investing services are the latest trend in discount brokering. This is where you do your own research, select your investment, and then trade online for a minimal fee. Finally, a full-service brokerage firm will charge a little more but they will provide you with information, support, recommendations and investment advice as well as execute transactions for you.

You can start by selecting a brokerage firm and then choose a broker from among its associates, or you can find the individual broker first, which means you accept the firm they work for. Either way it is important to take your time and do your homework.

Make sure you know how the broker is paid so ask for a copy of the firm’s commission schedule. Brokers are usually paid based on commission from the amount of money you invest and the number of completed transactions in your account. There will be additional compensation paid if a broker is selling his or her firm’s own investment products. Check on the fees or charges for opening, maintaining and closing an account.

At your first interview with the broker it is a good idea to obtain a copy of the account agreement, fee structure and any other documents that you’ll be required to sign if you go with that particular broker. You can then take the paperwork home to read everything at your own pace. You can then make comparisons as you consider several brokers. If you feel the prospective broker is pushing you too hard to open an account on the spot, you may consider this an indication that they could also be overly aggressive in pushing you toward certain investment decisions in the future.

There are many brokerage firms that will have additional brochures and other information that you can use to help further educate yourself on the ins and outs of investing.

We would suggest that you do a background check on the broker and their firm before you make a selection. You can obtain this information from NASD at: www.nasdbrokercheck.com.

A brokerage firm usually will require a customer to sign a new account agreement or an investment agreement, and it is in your best interest to carefully review the information contained in this document. Down the road, it could affect your legal rights regarding your account.

Account documentation prepared for you by the sales representative is also important information to review, and do not sign the investment agreement unless you thoroughly understand it and agree to its terms and conditions. It is a mistake to rely on verbal representations from a sales representative if they are not also written in the new account agreement.

The sales representative will ask for information about your investment objectives and personal financial situation, including your income, net worth, and investment experience. Be honest. The sales representative will rely on this information to make appropriate investment recommendations for you.

Before you complete the investment agreement, you need to decide on three very important points:

  1. Know who will control decision-making in your account. If you want to control the investment decisions made in your account you may, or you can decide to give discretionary authority to your sales representative to make investment decisions for you. When you assign discretionary authority to a sales representative they can make investment decisions based on what they believes to be best-without consulting you about the price, type of security, amount or when to buy or sell. Think seriously of all of the implications before you give discretionary authority to your sales representative to make certain that this arrangement is appropriate for you.
  2. Know how you will pay for your investment. As an investor, you will usually maintain a cash account that requires payment in full for each security purchase. Another type of account is a margin account, which will allow you to buy securities by borrowing money from the brokerage firm. You are then required to pay interest on that loan. You will have to sign a margin agreement disclosing interest terms. When you borrow money from the brokerage firm, they will have the authority to sell any security in your account, without notice to you, in order to cover any shortfall resulting from a decline in the value of your securities. If the value of your account is less than the amount of the outstanding loan, even for one day, you are liable for the balance. This could add up to a substantial amount even after your securities are sold. The margin account agreement will usually allow that the securities in your margin account to be lent out by the brokerage firm at any time without notice or compensation to you.
  3. Know how much risk you should assume. In an investment agreement, you need to specify your overall investment objective in terms of risk. Those categories of risk can be labeled as "income," "growth" or "aggressive growth." Beware of the differences between these terms, and make sure that the risk level you choose are in line with your goals. Make sure that the investment products recommended to you also come in line with the category of risk you have selected.
The brokerage firm may ask you to sign a contract to arbitrate any future dispute between you and the firm or your sales representative. The federal securities laws do not require you to sign such an agreement. Signing this sort of agreement says that you give up the right to sue your sales representative and firm in court.

You may have your securities registered either in your name or in the name of your brokerage firm. Ask your sales representative about the relative advantages and disadvantages of each arrangement. If you plan to trade securities regularly, you may prefer to have the securities registered in the name of your brokerage firm to facilitate clearance, settlement, and dividend payment.

Never invest in a product that you don’t fully understand. Be sure to consult information sources such as business and financial publications, as well as your local library, where you can read up on the fundamentals of investing and basic financial terminology.

It is a good idea to check with another brokerage firm, an accountant or a trusted business adviser to get a second opinion about a particular investment you are considering.

Keep good records of all information you receive, copies of forms you sign, and conversations you have with your sales representative.

Nobody invests to lose money, but it is a good to remember that investments always entail some degree of risk. Be aware that:

  1. The higher the expected rate of return, the greater the risk. This will depend on market developments, but you could lose some or all of your initial investment, or an even greater amount.
  2. Some investments cannot easily be sold or converted to cash. Make sure that you know if there is any penalty or charge if you must sell an investment quickly or before its maturity date.
  3. Investments in securities that are issued by a company with little or no operating history or published information can come with greater risk.
  4. Mutual funds, and any securities investments, are not federally insured against a loss in market value.
  5. Securities you own may be subject to: mergers, reorganizations or third-party actions that can affect the value of your interest. Pay attention to public announcements and information sent to you about such transactions because they involve complex investment decisions. You should fully understand the terms of any offer to exchange or sell your shares before you act. 
  6. Just because the past success of a particular investment has been spectacular, there is no guarantee of its future performance.

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