How Do Stock Brokers Make Money?
How do stockbrokers make money? The answers could have implications for your investments!
Unless you have a huge amount of money invested in the market and you're making your own trades, you probably use a stock broker of some kind. Hopefully you use a discount broker of some kind. Why does that matter? Because the incentives of how a traditional broker might work don't let him or her work in your own interest.
Duties of a Stockbroker
A stockbroker has specific legal requirements and duties. The most important is helping individuals buy and sell stocks, bonds, derivatives, and other financial instruments. For this assistance—actually mediating these transactions— you probably pay a flat rate every time. Granted, he or she has to do a little bit of work to make that trade, but if you're paying more than $10 per transaction, you're paying someone for work you could do yourself with an online discount broker.
Keep in mind that every dollar you pay someone to do work that you could do (and probably faster) is a dollar that's not earning money for you.
In the olden days, some unscrupulous brokers made lots of trades on behalf of their customers, churning their accounts to generate more commissions. This is illegal (and, at best, highly unethical). You're not likely to find this happening at a reputable brokerage, but it only highlights the fact that the reward structure of Wall Street has its agenda aligned strongly against yours.
What do stock brokers and investment brokers do? Depends what you're paying for, whether you know it or not.
How Much Do Stockbrokers Make?
According to the US Bureau of Labor Statistics, the median income for a stockbroker was $71,720 in 2012. As a median, half of all brokers make more than this amount and half make less. Keep in mind that this depends on experience and geography; brokers working in New York City will make more than brokers working in the Midwest, for example.
How much a broker gets paid depends on several factors of compensation.
Every time you call your broker to ask for advice, you're probably getting charged. Want a report on a stock you heard about? That'll cost you. Want a tip on a new ETF? Get out your wallet.
Again, there's nothing wrong with paying someone to help you do research or to do something you don't have the time or skill to do on your own, but ask yourself what you're getting for your money. If it's worth $50 not to do a few minutes of research on your own (and remember, you still have to read and understand whatever your broker sends you), it's worth it.
(There's still no excuse to invest in something you don't understand, however. That's just risky.)
Sometimes brokerages and mutual funds and other companies want to encourage investors to buy into funds and other investments. They'll offer brokers referral fees to sign up new investors. Sometimes these funds are good deals. Often they're not. You might get pressured into buying an underperformer only because there's an incentive for someone to sell it to you.
According to the PayScale stock broker survey, the largest source of wages in this profession (and the source with the largest range of variance) is commissions. As with many sales professions, with experience and promotions, salary often becomes a negligible component of total compensation—the better the broker, the more in commissions he or she expects to receive. Sometimes a stockbroker can make a six figure salary from commissions alone.
Where does this money come from? You already know the answer; the more you trade, the more you pay. Even if the broker's not providing specific value to you, you're still paying for his or her time and attention.
When Should You Pay Broker Fees?
Is it worth it to pay a broker for the work you can do on your own? That depends on the value you get from the broker. If you're getting good research and finding undervalued stocks that you couldn't (or wouldn't) find on your own, fees might be reasonable. If you're getting market-beating returns even after you take out a percentage of management expenses, it might be worth it. You can learn how to do stock research and picking on your own anyhow!
Most individual stockholders aren't seeing these amazing returns, however. They're paying handsomely every year for mediocre gains. (Ask yourself "how much does a stock broker earn from me?" and compare that to how much he or she makes for you.)
For this reason, you're often better off buying something with very low fees (I like to start with the S&P 500 Index Fund). Until you're confident enough to evaluate investments to see if you're getting the value you're paying for, stick with something with proven value and low costs. (See The Little Book of Common Sense Investing for more details.)