How to Find an Investment Broker That Won't Rip You Off

Despite the popularity of cheaper online brokerages like Etrade and TD Ameritrade, many investors still use traditional brokers where you still buy and sell by placing orders with a live person. The bad news is many brokers are under pressure from their bosses to sell you things that may not be in your best interest. Here's how to protect yourself.

People like dealing with live brokers because they think those brokers know more about the market, and can steer them away from bad investments and into better ones they can't find themselves. Most of the big name brokerage houses have a full-time staff researching companies, funds, and alternative investments. They pass that research on to your broker, which gives you peace of mind that you're dealing with someone who can steer you away from bad investments and into ones those using discount brokerages don't know about.

That's the theory, at least. That's not always the case, though, mainly because of conflicts of interest. The higher-ups in a big brokerage often decide to push a particular investment because they get higher commission on it. Then they pressure the brokers to steer their clients into those investments. Here's one of many such cases.

If you suffer loss because you were steered into bad investments, you have no remedy. You can't sue the broker, because the broker is not required to act as a fiduciary—someone who is by law compelled to put your interests above theirs. For example, if you discover that your estate's executor or your doctor did something to benefit themselves at your expense, you can sue them because they violated their fiduciary responsibility. Brokers are not bound by that.

In order to protect the investor in the street, the government is considering legislation that will require brokers to be fiduciaries. If passed, that will allow clients to sue brokers if they bought an investment which benefited the broker in ways which were not disclosed. Whether that law will pass, given the lobbying clout of the financial services industry, is an open question.

In the meantime, if you use a traditional broker, you need to do your due diligence to make sure you're getting someone reliable. Here are a few questions—some inspired by this Associated Press article and a few from my own experience—that you should ask before you act on their advice:

1. Find out what incentive the broker is getting besides the fee you're paying. If you're not paying anything, someone else is. Once you know that, you are better able to judge whether the advice you're getting is "sponsored" or objective. Look for fee-only planners, who you pay directly, instead of commission-based planners, who get paid for the products they sell.
2. Find out if your broker is acting as your fiduciary. A few are, but most aren't. If yours is, you can expect they will be a lot more careful with their advice, because it means you can sue them if there's a conflict of interest and that conflict caused you to lose money. (It's worth asking, but don't hold your breath. The vast majority of brokers, for obvious reasons, avoid becoming a fiduciary.)
3. Check out their credentials. CFP (Certified Financial Planner) is generally regarded as a high standard of objectivity. If your broker has other letters, it's worth your while to check out what they mean.
4. Check out the individual. If you've ever listened to the CNBC TV series American Greed, you will notice how many people did business with known felons, simply because the fellow looked honest. The Financial Industry Regulatory Authority (FINRA) keeps a database of all brokers, including any legal problems. Here is a link to a search page which should identify the most egregious bad apples. But you can also just Google the broker's name and do a little digging yourself, too.
5. Do your own homework on the investments they suggest. When a broker suggests an investment you've never heard of, take a few minutes to go to Yahoo Finance or Google Finance to check it out. Those sites are free, and have tons of information.
6. In the long run, your best bet is to wean yourself from personal brokers altogether. They have to be paid, and the only source for that money is you, the client, whether it's a direct fee, or a kickback from the investment they're selling. As a general strategy, using a discount broker to buy low-cost index funds is the cheapest and safest way to go.

It's nice to do business with someone you have a good relationship with. It is even better to do business with someone you've checked out. But it's best when you don't have to pay for something you no longer need.

Title image remixed from Vector3D (Shutterstock).