You Should Get What You Pay for--and Vice Versa

By TOM PETRUNO

July 4, 1999 12 AM PT

It’s a great life, being a stock broker today at a major full-service firm.

At least, that’s what the numbers would suggest. The average broker earned $158,201 in 1997, the latest figure available. You can bet that sum went up last year.

Average earnings, however, can be skewed by a few very highly compensated individuals. But even looking at median broker earnings (a fairer representation of what the typical broker took in) the 1997 figure was $119,010, according to the Securities Industry Assn., a brokerage trade group.

That still was more than 2.5 times the median U.S. family income of $44,568 in that year.

Now comes Merrill Lynch, the name perhaps most synonymous with stock brokerage, with a plan to kill the golden goose--by slashing commissions to a mere $29.95 for customers who simply want to use Merrill to trade, and who don’t particularly feel the need to have their broker’s blessing on each transaction.

It’s the Internet, of course. All of those online-brokerage ads painting full-service brokers as sleazy and useless are having an effect. You know--the broker on his yacht, laughing about his moron customers paying him all that money to simply churn their accounts and make him rich.

But let’s back up a bit. Millions of Americans have been using the services of Merrill Lynch, Morgan Stanley Dean Witter, Salomon Smith Barney and other major brokerages for a long time. Those firms’ customers tend to be educated people with considerable assets. The average Merrill customer’s account size is about $350,000, compared with a mere $25,000 for the average E-Trade account.

Hmmmm. Why would so many people of means still do business with full-service brokerages, when they could easily jump to any number of discount brokerages, take their money to an independent financial planner, or manage it themselves in no-load mutual funds?

Let’s consider a few possible answers:

* Full-service brokerage customers really are morons, albeit wealthy ones. OK, we can assume this applies to some percentage of those customers, but it’s highly unlikely to be the majority.

* Full-service brokerage customers know better, but inertia is a strong force, and it’s easier to just stay put. Again, this surely applies to some percentage--maybe the very wealthy (and carefree), older people who are fearful of new technology, and younger people who may have inherited money, and a broker, from their parents or grandparents.

* Full-service brokerage customers actually feel that they get some value out of their relationship with the broker and the firm, despite high commissions.

Having come to actually know some people who have used full-service brokers--and to know some of the brokers as well--I’d say the percentage of investors in this last camp is significant, if not a majority.

There already are many full-service brokers who do what Merrill Lynch wants most of its brokers to do: act as true personal financial consultants, not just opportunists looking to generate as many trades as they can fit in the 6 1/2-hour daily market session.

It’s not exactly a surprise that so many people with securities licenses still try to get hired on at the major brokerages. The resources available to brokers at those firms are impressive to say the least--the research, the technology, the access to new financial products, etc.

Why, then, do full-service brokers still get such a bad rap?

Because the brokerage industry is, on many levels, its own worst enemy.

There still are too many brokers who try to sell clients the firm’s own products (such as in-house mutual funds) for commission and for the firm’s benefit, rather than choosing products that would truly be best for the client.

There still are too many brokers who rely on the hated cold call--dialing up potential customers during their dinner hours to try and interest them in a stock, or mutual fund, or investing concept. I don’t even know you, and you’re trying to sell me something? Are you high or what?

There still are too many brokers who aren’t very interested in getting to know their clients’ financial needs. That takes a lot of time and work. It’s easier just to be an order-taker and earn hefty commissions.

As my colleague Thomas Mulligan points out in the accompanying articles, Merrill Lynch has good reason to want to move clients, and brokers, to a fee-based relationship. If a client agrees to pay a brokerage a yearly fee of 1% of assets under management for advice and transactions, that may remove the incentive for the broker to try to generate income by suggesting unnecessary or ill-conceived trades.

Most brokerages, and most brokers, also would prefer to have a stream of income they can rely on in good markets and bad, rather than depend on trading, which can be cyclical.

The problem is that, in making the jump from commission-based compensation to fee-based compensation, many brokers would have to sacrifice income initially--until (and if) they can attract enough client assets to close the gap of lost commissions.

Some brokers will simply have to face the cold facts: The Internet is bringing costs down in many industries. There’s little justification for mere human order-takers to rake in commissions that are 10 times or more what investors can pay to trade via the Net.

But if you can add value to a customer’s financial affairs--if you can provide good advice about a stock, an investment strategy or a retirement issue--that’s worth something, and probably much more than an E-Trade commission.

It doesn’t take a mental giant to understand that, as baby boomers get older and acquire more assets, they’re going to need financial help from somebody. Full-service brokerages have as much to offer as any other advice-provider, and often more.

Clients won’t materialize, however, unless the brokerage industry does a better job of policing its own ranks, and its own policies, and showing investors that the inherent conflicts of interest within a full-service firm (e.g., the desire to sell in-house products) can be tamed.

There also are some cold facts for brokerage clients and potential clients here. Merrill Lynch wants its brokers to be financial consultants, working for fees and providing well-rounded advice. Fine.

How many .300 hitters are there in baseball? Not many. How many great, all-around financial advisors are out there (not just in the brokerage business, but in general)? Not many.

The best broker/financial consultants already have more clients than they can handle well. Those top advisors typically set high minimum-asset requirements before they’ll take on a new client.

As with anything else, your ability to pay will largely determine the quality of advice you get. People with $100,000 in assets, perhaps even $500,000, won’t be able to expect the level of service and advice that wealthier people will get. Sad, maybe, but true.

That’s not to say those investors can’t earn decent returns. Indeed, the do-it-yourselfer in a low-cost Standard & Poor’s 500 index fund has done far better in the 1990s than the vast majority of “professionals.”

Finally, let’s turn to the much-maligned “stock jockey”--the stereotypical broker who got into the business for the action.

The increasing championing of the broker as all-around financial consultant is noble enough, but it’s worth remembering that some meaningful number of small investors also like the stock market for the action--the fun of winning on a short-term trade, the aggravation of losing.

There will always be room for brokers who still want to be fast-trading stock jockeys, because there will always be clients whose interest in the market begins and ends right about there.

Action is what makes a market. It would be pretty darn dull without it.

Times Senior Markets Editor Tom Petruno can be reached at tom.petruno@latimes.com

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Where the Brokers Are

Leading brokerage firms ranked by number of retail registered represenatives (1998 data):

Firm: No. of brokers

Merrill Lynch: 14,475

Salomon Smith Barney: 10,319

Morgan Stanley Dean Witter: 10,000

Prudential Securities: 6,473

PaineWebber: 6,249

A.G. Edwards: 6,169