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Sunday, June 13, 2010

Choosing the Right Broker


Investment books typically say that you can choose the right broker by checking their background, pedigree, past performance and investing style: the best brokers will have a track record of success.

Such advice seldom works. It assumes that making money is the client’s primary reason for choosing a broker. It also assumes that the investor actually wants to make money, which is not necessarily the case.

Investing is more about psychology than anything else. Therefore, choosing the right broker is mostly about psychology as well.

The descriptions here are written tongue-in-cheek, but describe real investors and real brokers. Recognizing which one of these reflects you most gives you a powerful advantage.


The Punching Bag – The punching bag broker is essentially a displacement target, whose main purpose is to serve as an outlet for frustration. For instance, a Japanese businessman who is surrounded by superiors may get scolded regularly, yet has no one with which to do the same. The broker, in this instance, would serve as the person against whom the powerless individual could vent his frustrations. Those looking for a punching bag broker should pick either a meek broker who is used to it, or a strong broker who won’t care. A punching bag broker can be an important source of stress relief through Freudian displacement (taking out your aggression against a socially acceptable target), and can lead to greater success in other areas of life, such as work and marriage.

The Thrill Provider – The thrill seeking client does not wish to invest in index funds or other practical investment vehicles, but rather wishes to be part of the exciting world of mergers and acquisitions, penny stocks and new issues. It is not so important whether the stocks go up or down, so long as risk and danger is omnipresent. A broker that specializes in thrill providing is usually a frequent trader, and will cost the client more in trading commissions and taxes. Selecting a thrill seeking broker is an excellent alternative to more harmful options like gambling, drugs, or marital infidelity.

The Loser – The hypochondriac investor should seek a broker with a mediocre record. This way, a client can tell his friends how much money he lost, how horrible it is etc. and get as much attention and sympathy (“injustice collecting”) as required. The loser broker is also good for those who are afraid that success will bring undue pressure to their lives, and so who just avoid being successful altogether. Note that those who use a loser broker are not investing to win, but rather are investing to intentionally fail; therefore, it is important to choose a broker who is not particularly successful. A moneymaking broker will not meet the required psychological needs.

The Arm Candy – Arm candy refers to a broker at one of the world’s top investment firms, whose membership requires a high initial investment amount or referral by an existing member. The purpose of the arm candy broker is primarily snob appeal. For example, a client can say, “My broker at Goldman Sachs told me…” and know that dropping the name “Goldman Sachs” implies a certain elite status and cache that a local boutique would not. Investment returns are not as important as having the account itself.

The Team Player – The team player relationship – perhaps the most healthy of all client-broker relationships - is when client and broker work together to create winning strategies. Good calls are held, and bad calls are dropped before they become overly bad. The client calls the broker just often enough to maintain a regular presence, but not often enough to annoy. With a team player broker, one will actually be working with a broker in a partnership, and so investing prowess and a match of styles is important. Team player relationships tend to break down into co-dependency.

The Discount (Online) Broker – Discount brokerages give no investment advice at all, so winning or losing is completely due to individual investment decisions (assuming the investor does not ask friends, lovers etc., in which case that person becomes the substitute broker). Those who use discount brokers love the intellectual challenge of investing, and tend to believe that they are superior to most other investors. During the early and middle stages of market cycles this idea of superiority may have a grain of truth to it, but is definitely not true during bull markets, when uneducated investors open accounts in droves. Discount brokerage users also tend to believe that their strategies are “secret,” even when they are buying small amounts of stock in large corporations that trade millions of shares a day. Since they are working alone, discount brokerage users must be keenly aware of their own psychological shortcomings (hint: if you make a mistake once, it is a mistake. If you make the same mistake several times, it is not a mistake).

The broker descriptions above are, of course, not exhaustive, and several types may be blended together. Nevertheless, knowing your own motivations – and making sure these motivations are healthy – is useful knowledge. By eliminating those motivations that are most unhealthy, investment success can be improved exponentially.

"He is a masochist who wants to lose."
Sigmund Freud, in regard to compulsive gamblers