The Devil is in the Details

Through years of working with individual investors I often heard comments such as “Oh, my broker doesn’t charge a fee for managing my assets.” It sounds like a bargain at first, but if you dig deeper, you will discover that brokers are being compensated through various fees (some obvious, some not) including commissions from trading municipal bonds.

A recent study conducted by the Wall Street Journal showed that investors who purchased municipal bonds were paying their brokers about twice as much in trading commissions as they would for corporate bonds.

Unlike corporate bonds, municipal bonds change hands far less frequently and in smaller amounts. Average retail investors have limited access to pricing information and brokers are able to pocket higher commissions.

Data released by the Municipal Securities Rulemaking Board (MSRB), a self-regulatory organization that oversees the municipal securities market, showed that brokers charged an average 3% markup on a $1 million Massachusetts bond offering sold to investors. In other words, brokers collected $ 30,000 profit on a $1 million municipal bond trade, which seems quite high to me.

When interviewing a prospective financial adviser, an individual investor should always ask this question: “How do you get paid if I were to hire you?” It is important to understand the total cost of the service your adviser provides since all costs, hidden or otherwise, will lower investment returns.

All comments and questions are welcomed.

Wenma Gorman, CFA