Saturday, August 21, 2010

Full Service Brokers --- Cash cows, or pigs, for how long

That full service brokers with a large customer base are sources of significant annuity-like income is well known. I recently have learned that the prices they charge are astounding. This not only speaks to the current income value of the franchise but also to the questionable viability of their business model for the long term.

Why do I say this. This year I have been managing two modest accounts, an IRA and a general account primarily full of illiquid mortgage backed securities(another story recounted here previously), that are going through probate. The accounts are domiciled at one of the three largest full service brokers. The current account rep(forget the prior one) is pleasant and helpful but never calls with ideas or suggestions. All interaction is related to my calls to him. These have involved liquidating some assets to satisfy the will, and both administrative screw-ups by them and what is perhaps an illegal change of a trade, in their favor, a week after execution. Working with this account has been no picnic. This is seen through the lens of working with the excellent service and admin of Fidelity, Schwab, and E-Trade for many years.

Last week I decided to make some conservative investments in the accounts as money was building up in the broker's "Bank Deposit Program" core account that pays .01% interest. I called but my broker was out for the week. I was told that another broker there could execute my trades. Between the two accounts I asked for five trades. I bought 120 shares of SHV for each account, a short term U.S. treasury ETF that actually has a yield, 150 shares of Johnson and Johnson for the IRA, and 250 shares of AT&T and 250 shares of Lilly for the general account. The combined commission for these five simple client initiated trades was $1650. At my usual brokers, listed above, the total commission would have been approximately $40. That's material.

I was charged the broker's standard charges. Individual customers have built-in concessions but, it turns out, with my individual broker out of the office there is no system that gives anyone else information about customer status or pricing, or so they say. What century are we in. When my broker returns on Monday a large part of these charges should be reversed, but if my experience with the "illegal" trade revision is indicative(promised but still hasn't happened), it takes a second to do something wrong and months to remedy it. Maybe the customer will forget, since so many of their long time customers are elderly.

That gets to the overall thought. These firms, or this one, provide inconsistent service but always with a big smile. They charge commissions that have no economic justification if they can get away with it. They are vestiges of the past. The customer base of these firms is aging and will over time not be replaced. At these types of commissions brokers are not only willing to stick it out but also incented to churn accounts. The combination of bad systems, mediocre service, administrative errors, and huge commissions is a tough formula to beat. Just be sure and have a nice day.


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