Choosing a Broker
Investors purchase stocks to make money over the long-term. Brokerage-dealers are a part of this process, and bridge the gap between the investing public and institutions that are in need of capital financing. The financial marketplace offers separate classes of broker-dealers, through which savers may implement their respective financial strategies. Be advised that transacting business with broker-dealers carries distinct risks.
The Securities and Exchange Commission identifies brokerages as fiduciaries that execute financial transactions your behalf. At first, corporations issue shares of stock to secure financing at initial public offerings (IPOs). From there, shares trade directly between investors within what is referred to as the secondary market. Broker-dealers provide the information technology and infrastructure to organize buyers and sellers together, so that they may negotiate prices between themselves. Financial markets function as large auctions, where asset prices are established at points where the highest bids and lowest sales offers intersect.
Traditional Versus Discount Brokerages
Broker-dealers may be categorized into either traditional, or discount firms. Traditional brokerages are actually full-service financial advisers that provide investment recommendations, alongside plans that effectively structure your insurance, cash management and employee benefits packages. Traditional brokers may charge by the hour, or accept annual fees for these services. Alternatively, discount brokers strictly execute transactions, without offering advice. Discount brokers, such as Scottrade and E-Trade, are recognized for their online presence and low trading commissions.
Brokerages operate as dealers when they buy and sell securities for their own account. These transactions are referred to proprietary trades, which are designed to improve the profitability of the overall firm. The broker-dealer may purchase shares of stock to hold for inventory, before selling these investments to its own clients. The Securities and Exchange Commission requires that financial intermediaries disclose the fact that they are operating as a dealer when offering proprietary stocks to clients.
Broker-dealers introduce liquidity to financial markets, which lowers overall costs for all investors. Liquidity describes the ease of which any asset is converted into cash. Within seconds, investors can sell investments through broker-dealers for cash. Without brokers, buyers and sellers would be forced to either spend time and money soliciting prospects to trade investments, or buying expensive memberships at financial exchanges. Professional traders may purchase these memberships for $1 million, or more.
Broker-Dealer and client relationships introduce conflicts of interest, which may lead to severe losses for savers. As dealers, firms may exploit their position to sell off their own losing investments to clients that quickly fall in value. Further, traditional brokers have been accused of churning accounts. Churning refers to recommendations that are made to encourage heavy trading, for the sole purpose of increasing brokerage commissions.