Your stock broker – understanding conflict of interest

Many investors are not comfortable with Mobile Trading applications for their trading activities in the stock market. They usually rely on traditional stockbrokers who take orders over the phone. The traditional stockbroker profession is in decline as a result of digitalization. Like many of us, they buy their Airline tickets and book their hotels themselves rather than using the services of a travel agency.

Is your traditional stockbroker guiding you in your best interests? If your answer is yes, you need to assess this once again.

There are several conflicts of interest between a traditional stockbroker and an investor.

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Commission-Based Earnings

The traditional stockbrokers generally make money from fees or commissions on trading activities, which may compromise an investor’s return on investments. Since they make money every time you place a trade, it is in their interest that you trade more frequently.

It is common for such a trader to suggest that an investor should book their profits as stock markets are unpredictable. This may be appropriate for trading stocks, but not for quality stocks. The investor benefits by holding excellent companies’ stocks for the long term. Capital Gain Tax on capital gain and brokerage will apply to such trades.

If you hold a stock for a few years, you will still have to pay the capital gain tax, but only once at the end.

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Brokerage House Interests

The brokerage house is also a business with an objective of profit maximization for its owners or shareholders. A brokerage house, because it trades for a big number of clients, can inflate demand artificially without any underlying change in investment thesis.

Similarly, the brokerage house may buy or sell a stock ahead of client orders to gain an advantage. This is called front-running.

These activities may even be illegal, which is why investors need to choose their broker carefully.

Order Flow

A traditional broker may prioritize clients’ orders based on how much money he earned from a client and the client’s account size. They can prioritize institutional clients’ trade first. This may lead to not getting the best price for each investor.

An online trading platform can eliminate or minimize this phenomenon.

Investment Advice

All brokerage houses are not the same in terms of research, analysis, and business ethics. Likewise, all traditional stock brokers are not and cannot be equal in their knowledge, financial acumen, and market experience. They can recommend investments that are good for an investor and help them make some money. The investor’s profit maximization with little trading activity is definitely not the broker’s prime objective. An investor should always perform their independent research or analysis rather than blindly following their traditional stockbroker’s recommendations, and frequent trades.

Conclusion

Warren Buffett said, “Risk comes from not knowing what you’re doing.” You are investing your hard-earned money in stocks. As you develop your plans for an investment portfolio, you should be sure to take a level of risk and aggressiveness with which you are comfortable.

You should put some effort to learn and mastering online trading.

Similarly, you should familiarize yourself with companies, their businesses, and their financial performance before making an investment decision.

You are your own best friend. Remember that no guru or pundit has a working crystal ball that can predict what is going to happen with the economy and financial markets in the future.

⚠️ This post reflects the author’s personal opinion and is for informational purposes only. It does not constitute financial advice. Investing involves risk and should be done independently. Read full disclaimer →