Should You Dump Your Broker?

EDITOR'S NOTE: In this special report, SmartMoney examines a dilemma facing investors around the country—and what brokers are doing about it. For a look at the best and worst brokers in key categories, look for our 2009 broker survey in the June issue of SmartMoney magazine, arriving in subscribers' mailboxes and hitting newsstands soon.

Is it time to switch brokers? Across the country, shell-shocked investors are asking themselves that question: About 40 percent of brokerage customers say they either changed brokerage firms last year or are considering it, according to a survey SmartMoney conducted with the help of research firm Synovate.

News from the front lines of the financial crisis—from the collapse of Lehman Brothers to some messy broker mergers—hasn’t exactly shored up consumer confidence. But something else has been damaging the bond between customers and their brokers: a nagging feeling that both the pain of last fall’s crash and a slow response to recent market swings have made things worse than they had to be.

Many investors think full-service advisers “failed them in trying times,” says researcher Matthew Bienfang of Tower Group. At the same time, discount brokers are waging their own battle to placate disgruntled customers. A recent survey from the University of Michigan shows discount brokers suffered the steepest decline in customer satisfaction among e-commerce businesses. “We’re never happy when our portfolios are dropping like a stone,” says Larry Freed, CEO of research firm ForeSee Results, which worked on the survey.

Not everyone is firing his or her broker, of course. But the shift, along with the upheaval caused by the financial crisis, suggests that no matter where the market goes from here, a shake-up is at hand in the $100 billion industry after years of relative calm. Consolidation has already started, with Bank of America’s (BAC) acquisition of Merrill Lynch and the planned joint venture of Morgan Stanley (MS) and Citigroup’s (C) Smith Barney.

Now, says brokerage analyst Mark Lane, of William Blair, big brokers will try to become more efficient by stepping up efforts to weed out underperforming advisers. Experts say that as more customers with smaller accounts are shunted aside, discount brokers will try to entice them with new technologies to put more research and advice tools at their fingertips.

Brokerage firms can hardly be blamed for the worst bear market since the Depression, or even for failing to predict that it was coming. But analysts say they made other mistakes, such as pushing complicated debt instruments like auction-rate securities as a safe alternative to money-market funds. Full-service and discount firms alike had egg on their face as the market for those securities froze up and angry customers couldn’t get their money. Some promoted so-called target-date mutual funds as a “set it and forget it” retirement vehicle, only to see many of them crash with the market. According to a study from Forrester Research, only 45 percent of investors believe their brokerage firm does what’s best for its customers and not just its own bottom line—the lowest level in four years.

But for many clients the biggest disappointment has been how brokers simply haven’t kept them in the loop, both when their accounts went into free fall last winter and when they ricocheted this year. William Lamberty, a water-supply technician in Romeoville, Ill., says he called and emailed his broker a number of times last fall. But the 52-year-old investor says it was only after increasingly frantic follow-up calls that his broker scheduled a face-to-face meeting after the initial crash. By then Lamberty had lost more than $56,000 and decided to transfer his account to a discount firm, where he could manage his investments on his own. “I got disillusioned,” he says. (His broker says he follows a schedule to contact clients once every quarter and that Lamberty “was pretty well covered in terms of conversations back and forth.”)

The discontent with expensive advice hasn’t been lost on discount brokers, whose commissions are typically a small fraction of those of full-service brokers. Analysts say there’s been a surprising jump in trading at discount brokers, as some investors try to make up for losses and take advantage of the market’s volatility. Even amid the worst bear market since the Depression, the number of new online accounts jumped 14 percent last year, to 1.7 million, according to Tower Group. The research firm expects another 4.5 percent increase this year. TradeKing CEO Don Montanaro says his firm has seen a “surge” of customers moving from the big full-service brokers, contributing to a 42 percent jump in new accounts in this year’s first quarter.

But not all the movement is from full-service firms to discounters; restless customers are also switching from one discounter to another. At the same time, some full-service firms, particularly regional outfits, are picking up business. James Weddle, managing partner of Edward Jones, boasts that his regional firm has snatched accounts from the industry’s biggest players—and that these new customers brought in more money than the firm lost from defections.

The sweeping changes could spell new opportunities for savvy investors. When Kathryn Korbon, of Charlottesville, Va., opened an account at discounter E*Trade (ETFC), she was awarded up to 100 free trades. Other investors shopping around for the right fit have been inundated with all sorts of free offers, including airline miles, an iPod Nano and even a new BlackBerry smartphone.

But once you get past the freebies, going solo isn’t as easy as it looks. For Korbon, switching her accounts to a discount broker required a whole new level of attention to detail. With the stock market going haywire, she soon found herself doing everything she could to keep up: reading financial blogs, listening to online seminars on investment subjects like options trading and checking her portfolio three times a day. “This is not supposed to be my day job,” she said on one of the many days the market was in free fall.

Moving to help fill the knowledge gap, some discount brokers are rolling out new programs to guide investors through the market’s ups and downs—and skating closer to the turf of the full-service giants. TD Ameritrade (AMTD) offers a program that includes eight weeks of training on investment topics, followed by four weeks of coaching by a TD Ameritrade adviser. At $2,400 for a three-month membership, the extra help doesn’t come cheap, though it can still be less expensive than shelling out $150 to $300 an hour for a fee-only financial planner.

Discount brokers have been racing to outdo each other on a litany of services, in fact—24-hour phone access, customer-service chats and freshly minted podcasts, to name just a few. When Schwab (SCHW) CEO Chuck Schwab and Chief Investment Strategist Liz Ann Sonders conducted an online town hall meeting to discuss the markets, nearly 10,000 people watched it live. And it’s not just the small fry they’re after: Schwab recently doubled, to nearly 140, the number of customer-service reps serving investors with more than $1 million in assets.

Full-service brokers argue that means clients want more hand-holding, not less, in these turbulent times. At UBS (UBS), clients can dial in to a weekly conference call to hear the firm’s research team discuss the current market and investment opportunities. Smith Barney says it has gone into “communication overload”—doubling contact with its clients and offering more educational seminars.

As clients grow more comfortable with online tools, full-service brokers are also beefing up their web sites—traditionally an area of strength for discounters. Raymond James, whose site earns top marks in SmartMoney's new web site evaluation, has been adding more online videos so clients can hear the firm’s analysts discuss the latest market moves. “There’s an unprecedented thirst for advice,” says Chet Helck, chief operating officer of Raymond James.