Financial Terms / A - B / Broker

What is a broker?

A broker is a licensed individual who acts as an intermediary between buyers and sellers in regulated transactions. They guide you through the process, helping with market research and data analysis to ensure you get the best deal possible. Brokers exist in various industries, including finance, real estate, insurance, and trade.

Stock Brokers

Stock brokers facilitate transactions in the financial markets, trading securities like stocks, bonds, and options on behalf of their clients. There are three main types of stock brokers:

1. Discount brokers: They manage trades and charge low commissions but don't provide financial advice.
2. Full-service brokers: Also known as advisory brokers, they offer investment advice but typically charge higher fees.
3. Discretionary brokers: They can make trades without consulting the client but often charge more for their services.

Real Estate Brokers

Real estate brokers have a higher-level license than real estate agents. They represent buyers or sellers in property transactions, helping to find suitable properties or buyers, drawing up contracts, and negotiating sales. Real estate brokers also facilitate inspections, appraisals, and handle sale contingencies.

Insurance Brokers

Insurance brokers work independently, offering policies from various insurance companies. They help clients find the right insurance products for their needs, whether it's health, auto, or life insurance. Unlike insurance agents who represent specific companies, brokers prioritize their clients' interests, providing unbiased advice and access to a wide range of insurance solutions.

Mortgage Brokers

Mortgage brokers help homebuyers secure loans by connecting them with various lenders. They assess your financial situation, determine appropriate loan amounts and types, and submit applications to lenders. Mortgage brokers can often access exclusive deals and potentially save you money over the life of your loan.

How Brokers Work and Make Money

Brokers earn money through various methods, each with its own implications for clients. Understanding these compensation models helps you make informed decisions when choosing a broker.

Commission-Based Income

Many brokers work on a commission basis, earning money from transactions they execute for clients. This model can lead to potential conflicts of interest. For instance, some brokers might engage in "churning," excessively buying and selling securities to generate more commissions. A 2015 White House report estimated that conflicted advice costs savers about $17 billion annually.

Fee-Based Income

Fee-based brokers earn through a combination of fees and commissions. They might charge a percentage of assets under management (AUM) plus commissions on product sales. For example, a fee-based advisor might suggest rolling over your 401(k) to their in-house funds, charging a 1% AUM fee plus a 3.75% to 5.75% front-end sales charge.

Salary and Bonuses

Some brokers receive a base salary plus bonuses. However, many, especially those at major firms like Edward Jones or Merrill Lynch, operate more like independent contractors. Their income primarily comes from the clients they bring in, with little or no base salary from the firm.

Regulatory Requirements

To protect investors, brokers must comply with strict regulations. The Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) oversee broker-dealers, enforcing compliance with securities laws and conducting examinations. Brokers must maintain accurate records, conduct regular audits, and file reports with the SEC.

Choosing the Right Broker for Your Needs

Evaluating Broker Services

When selecting a broker, you need to consider the services they offer. Some brokers provide full-featured trading platforms with complex software, while others offer simpler, user-friendly approaches. Look for brokers that offer research tools, stock screeners, and portfolio analysis features to help you make informed decisions.

Comparing Fees and Commissions

Fees matter when choosing a brokerage account. Many brokers now offer commission-free trades for stocks and ETFs. However, some still charge for mutual fund trades and other services. Compare fee structures, including account minimums and margin rates, to find the most cost-effective option for your needs.

Checking Credentials and Reputation

It's crucial to verify a broker's credentials and reputation before doing business with them. Use FINRA's BrokerCheck tool to research the professional backgrounds of brokers and brokerage firms. This free tool provides information on a broker's qualifications, registration history, and any disciplinary actions.

Understanding Broker-Client Relationships

The relationship between a broker and client is based on trust and confidence. Brokers have a fiduciary duty to act in your best interest, providing care, confidentiality, loyalty, obedience, disclosure, and accounting. Ask potential brokers about their approach to client relationships and how they prioritize your financial goals.

FAQs

What considerations should I make when selecting a broker?

Before choosing a broker, it's important to understand your financial goals and investing style. You should evaluate the features and fees associated with different accounts, assess the research tools and amenities offered, check for security measures and account protection, and test the online brokerage platform. After these evaluations, you can make an informed decision on which broker to choose.

What is the primary role of a broker?

A broker primarily functions to address a client's problems in exchange for a fee. Secondary functions include providing loans for margin transactions and offering informational support about market conditions. Brokers can be categorized into three types: online, discount, and full-service brokerages.

How do brokers generate income for you?

Brokers can help you earn money by sweeping idle cash in your investment account into a deposit account that accrues interest. You receive a portion of this interest, while the brokerage retains the remainder. Additionally, brokers earn fees from selling trades to market makers.

What should you expect when working with a broker?

When working with a broker, you can expect them to help you understand your financial needs and goals, determine your borrowing capacity, and explore suitable financial options for your circumstances.