Be Wary of Your Broker: He Might Be Smart Enough to Be a Danger to Your Portfolio

By Dr. Steve Sjuggerud, President, Investment U
Monday, December 15, 2003: Issue #298

If you’re not comfortably making six figures and you’re not under 45 years old, then you weren’t invited…

Well, it didn’t say that on the invitation. But that was the case at a highbrow Christmas party I attended over the weekend.

There were plenty of little subplots I could fill you in on. For example: Most of the men said, “I’m in real estate these days,” making me think that a real estate peak may not be too far off; while many of the women seemed to have dramatically gained weight “above the bellybutton” since last year’s party.

But the thing that struck me the most (and scared me the most) was a conversation I had with a “successful” stockbroker…

Your broker may be smart and nice. He may dress well. And he may say all the right things. But he still may lose you a pile of money…. Let me explain…

The “Successful” Broker

The broker I talked to is an upstanding member of society. He’s been a broker most of his life. He works for what I consider to be one of the very best full-service brokerage firms in the business.

He is a nice guy. He probably takes good care of his clients and tries to do the right thing for them. He no doubt makes a heck of a lot of money – he was at this party, wasn’t he?

But he really had no clue about how to make money…

How a “Successful” Broker Can Lose Your Money

“I like China,” he starts off saying, “and nanotech What do you think, Steve?”

These were the first red flags that this broker will never make his customers a mint.

I gave him my honest answers that China is a bubble like the Nasdaq in 1998, and that nanotech is a long way off.

Specifically, about China, I said, “Sure it can double from here. But it will end, and the end will be ugly.” China-related stocks are up many times this year – and some of these businesses barely have any sales. Companies can raise money now (IPO) in China at 20 times earnings – companies will line up to raise money at those levels.

People are buying China without thinking, just as they did in late 1993.

The China story today is exactly the same story we heard in 1993. China stocks peaked in early 1994, and the MSCI China Index fell 90% from 1994 to early this year. Now it’s taking off again. I think he’s getting in late. He may make 100% on the upside, then he’ll lose it all and then some as it tanks. I’ve seen it happen too many times.

About nanotech, I told him:

“It feels to me like the great boom in power stocks after the power crisis in California a couple of years ago. All the alternative-power stocks [like Ballard, Plug and Active] soared. Of course, none of them had any hope of making money for many years. And all of them subsequently crashed hard.”

Nanotech is the same –  there is promise, but no profits, and it could be many years.

I’m not sure if the broker listened to me, or if he had already made up his mind about these things and wasn’t interested in my opinion. As a broker, you need a good story to tell to your clients. “Never let the facts get in the way of a good story,” they used to say when I was in the brokerage business.

In order to smooth things over, I offered up a suggestion “Well, you could buy these for the rise, and use something like a 25% trailing stop that way your upside is unlimited and your downside is limited in case things don’t go right.” Again, a polite nod was all he gave me.

How to Save Yourself from Danger

“So what do you focus on?” I asked politely, trying to ease any tension I’d built.

“Oh, I mostly do safe stocks, like Microsoft and other big tech stocks.”

“Oh,” was all I could muster.

To myself, I thought about some of the best investing advice I ever received: “Things appear safest when they are the most risky, and vice versa.”

We talked a bit more. But I left thinking that this very nice, smart, caring person was about to lose a lot of people a lot of money.

And he’s one of the good ones A good firm With good intentions

While you may have a good broker too, you’ve got to stay on top of him. You’ve got to cut your losers no matter what. You can’t be overloaded in “safe stocks” – stocks that have performed in the past, but are now expensive. Basically, you need to follow what we’ve laid out in these pages.

Why “Hands-Off” Can Equal a Drop-off in Profits

In short, no matter how successful you get, you can’t just hand the ball over and forget about it. I’m sorry. Even the best still don’t do these basic things. They live and die on “buy and hold.” But buy and hold may not work this decade, as we’ve covered here many times before.

Find the best help you can. But stay on top of things yourself, too. You have to. Otherwise you might not have enough to get invited back to this Christmas party again next year. And that’ll be the least of your problems

Good Investing,

Steve

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