For this post, I interviewed dozens of stockbrokers and surveyed hundreds more to collect their views on stockbroking. The result is a collection of thoughtful and intelligent takes on the world of advising clients on their investments and portfolios. Because my research was anonymous, many of the takes are funny and witty, and they are definitely brutally honest.
It's like having a connected friend in stockbroking telling you all the secrets of how stockbrokers really work. I hope you find this post illuminating and useful for navigating your relationship with your broker, or your career in stockbroking. Please feel free to contribute if you have anything to add to the discussion.
Top 5 Takeaways
If you only have a few minutes to spare, here are the top 5 takeaways:
- Stockbroking is all about the story. Clients buy narratives, so stockbrokers spend a lot of time finding stocks with a strong narrative and working on how they are going to position it, pitch it and tell the story to their clients so that they buy it.
- Brokers make money when you buy or sell, not when you make money. The incentives are fundamentally misaligned. This means a broker's incentive is to do enough to keep you as a client and to maximize your buying and selling. Not to make you the most money. This is very important, but little known.
- Always ask your broker to show you their work. When they are recommending that you buy or sell a security then it needs to be based on something. Make them share it in detail. If they have done little or no work on it, then you should know this going in and make your decision with eyes wide open.
- Stockbrokers often treat their clients really well to their faces, and they are less kind behind their backs. This makes sense, they are in the client service business. They are not your friends. They are a service provider. You should know this.
- Scuttlebutt is a real thing, and a massive source of value from brokers who do their work and put boots on the ground. By getting close and paying attention to the business activity of a mining services company, one broker accurately predicted a plunge in commodity prices for their clients, and saved them millions.
These are just 5 interesting snippets from the interviews and surveys with stockbrokers, and the full responses are below. Please read on for more insights on stockbroking (point #16 and #19 are my favorites). If you’re leaving now, do you want to know how to 10x your impact in your chosen field? You should sign up for free and I’ll show you how.
19 Insights on How Stockbroking Really Works
1. It’s all about the story. Clients buy narratives, so stockbrokers spend a lot of time finding stocks with a strong narrative and working on how they are going to position it, pitch it and tell the story to their clients so that they buy it.
2. Stockbroking is a declining business. When I got into the industry we charged our institutional clients 20 basis points (0.2%) and now it’s 2 basis points (0.02%) on their trades. So our prices have gone down 10x.
3. A lot of institutional clients have moved their research and execution capability in-house, meaning they find their own trades or investments and have direct access to the exchanges to buy the securities themselves. Retail clients have moved to online brokerages like Charles Schwab and Robinhood. We’re getting crunched on both sides.
4. It was a business where anyone could show up to work and make money, now it’s tough going. It’s been a brutal change.
5. We don’t make money if you make money, as in to say, we make our money when you buy or sell, not on your profits. So our incentives are fundamentally misaligned. This means a broker's incentive is to do enough to keep you as a client and to maximize your buying and selling. Not to make you the most money. This is very important, but little known.
6. Because of the business model in stockbroking we prioritize finding and serving new clients, not putting all our energy into older existing clients.
7. Stockbrokers can make a lot of money on placements, and can have perverse incentives to encourage you to put your money into them, so it’s important that you know how they work. A placement (as it’s called in my country) is when a listed company raises fresh capital by issuing new shares to existing and new shareholders. Usually small companies, and say for example, $10 million. The way to incentivize brokers to help them raise this money is by offering a commission for the money they help the company raise. This commission can get as high as 10%. So for raising $10 million, brokers can earn $1 million in fees. That’s why they are so keen to fill placements for small, often highly risky and speculative companies. You need to be aware of this dynamic when considering participating as a new investor in a placement.
8. Most placements are completed to pay the salaries of management and the fees to brokers. This might be an unpopular statement, but even if it is unfair, always remember “caveat emptor” or let the buyer beware. Best to go in with this assumption and stay on your toes.
9. Still on placements, there is another incentive the company provides, and this one's for new and existing shareholders. They do the placement at a discount to the last share price. So if the company was trading at $1, you can buy it for 90 cents. An instant 10 cent profit! However, you are meant to give a promise that you will hold the share for a year. I have heard of one broker's client who makes a tidy side profit by participating in placements and instantly selling the shares, pocketing the 10 cents every time.
10. Always ask your broker to show you their homework. And I mean their homework. When they are recommending that you buy or sell a security then it needs to be based on something. Work that goes into making the recommendation. Make them share the arguments, the data, the models and the thinking behind the recommendation. If they have done little or no work on it, then you should know this going in and make your decision with eyes wide open.
11. One of my colleagues was putting his clients into an energy company based in South America, and it had a great story he could sell to them. When my team did the model (using his assumptions) the investment just did not stack up. The company's projects were uneconomic using even more generous assumptions for prices, costs, timeframes, rates and capital expenditures. When we presented the work to him (gently, of course) he freaked out and got angry at us. The data killed the narrative and stockbroking is driven by narratives, not data.
12. If you can, always ask for a second opinion when considering acting on a recommendation from a broker. It is simply best practice to seek a third party to validate the underlying assumptions behind the recommendation.
13. Most of the time, your broker does not have their money invested in the companies they are recommending to you. I know that all people have different financial situations and the ideal portfolio is not the same for everyone. But here I mean the small-cap brokers recommending speculative stocks to their clients because they are going to be “10-baggers”. If they are so certain it’s going to be a 1,000% gain, why wouldn’t they invest? Ask them if they have invested and have high standards for accepting the reasons you get back.
14. Stockbrokers often treat their clients really well to their faces, and they are less kind behind their backs. This makes sense, they are in the client service business. They are not your friends. They are a service provider. You should know this.
15. I was at a client event once and saw a broker schmoozing a client and their partner. Sitting with them and acting really engaged in the conversation and interested in their lives. Then a super high-net worth client walked into the room. The broker got up and vanished to their table so quickly I got whiplash. There’s always a bigger fish.
16. Scuttlebutt is a real thing, and a massive source of value from brokers who do their work and put boots on the ground. I’ll give you an example. There was a mining services company we followed that had a business buying and assembling locomotives for the big mining companies. They took ownership between the manufacturer in the United States and the mine in Australia meaning they were on the hook in case the miner didn’t pay for the train. But this had never happened. Until it did. The big mining companies stopped buying the trains and left this services company holding two expensive and idle locomotives. Imagine that. Each extra train meant more revenue and profit for the miner, but they paid the penalty in the contract not to take delivery of the train. From there, the iron ore price promptly plummeted. We stumbled upon the best lead indicator through scuttlebutt and our clients were forever grateful.
17. When you add value for clients, they don’t always have to act on it for stockbrokers to make money. Clients often pay “tags” which means they send trades to a broker that has provided them with value as a way of showing their thanks. Goes to show that you can make money indirectly by adding value.
18. Speak to brokers who meet with company management teams. This is a really valuable activity and there is always lots to learn. Usually it’s not from what they say (they can’t say much) but how they say it and their general body language and attitude. You want your broker to be one of the ones who does their work!
19. I learned this trick from a mentor in the stockbroking trade. He knew a broker who made a habit of meeting company management. Now company management can’t give much away, only public information. But they also don’t want incorrect information being priced into their stock price. Given that financial results and forecasts move the market, this gentleman would throw out a ridiculously large or small number as an estimate. If the forecast revenue was $100 million, he’ll tell them someone told him it was going to come in at $150 million. This number would be so ridiculous that it would always elicit a response. They couldn’t tell him anything concrete, but he’d always learn a lot from their reaction.
I hope these insights from current and former stockbrokers informed you about the true nature of stockbroking and provided useful information on how to navigate your relationships with your financial providers. There is a lot that stockbrokers bring to the table, if you use them correctly and I hope this post has made it clearer how you can set off on that path.
Before you go: I have interviewed 500+ professionals, surveyed thousands more, and I am always probing for their best tips, tricks and hacks to get ahead. There are five that stand out above the rest and you can get them right now by joining my free email list. You won’t find these ideas anywhere else.