Beware of referrals from stock brokers to investment advisors

There are two situations of which investors should be wary.

The first is known as a “wrap account”. In this situation, a stock brokerage firm recommends an investment advisory firm to an existing brokerage customer.  The customer signs a contract with the advisory firm and the brokerage firm shares in the fees.

This is problematic for two reasons. First, wrap accounts are frequently expensive.  The customer is paying a percentage of his/her assets every year for management and the manager is obviously willing to accept only a portion of the fee for actual management. 

So what is the stockbroker doing for its share of the fee? Frequently nothing.  More frequently, the wrong thing.

The brokerage firm is supposed to be watching out for the customer’s best interests. This type of fee arrangement doesn’t make it easy for the brokerage firm to do that.   Many customers have been told to “stay with” advisors who are losing money because the brokerage firm doesn’t want a change, and for no other reason.

The other type of referral from a stockbroker to an investment advisor that is problematical, is the referral programs from firms that “clear transactions” for investment advisors but don’t actually monitor how well the advisors are doing.

For example: Charles Schwab & Co. has a network of investment advisors that it regularly recommends to customers who ask for a recommendation.  But Schwab does nothing to monitor the performance of the advisors it recommends so it is likely that Schwab will recommend advisors who lose money for customers year after year. 

Stay away from referrals like this that are nor supported by meaningful performance information.  They have limited value.