Fiduciary brokerage: What is it and why does the market need it?
The story of novice investor
Meet John — a regular guy that has heard that investing can bring you money but didn’t immerse himself in the topic too much. After all, how hard can it be to create an investing account and buy a few stocks from time to time?
John opened an account with a traditional broker and started receiving investment advice. His broker encouraged him to trade frequently, and he trusted their expertise and followed their recommendations.
Over time, John realized that he was losing money. But his broker told him it was just a temporary setback and that he should keep investing. And he did it.
What John didn’t know is that his broker was earning a commission on every trade he made, regardless of whether it was profitable for John.
How do traditional brokers make money?
Traditional brokers offer a range of investment services, including personalized investment advice, portfolio management, and investment research.
But the main question is not who they are but how they make money. That’s where the problem of conflict of interest between brokers and clients lies.
Here are some of the ways traditional brokers make money:
- Commission for each order
When the client is buying or selling an asset on an exchange, the broker may charge either a fixed percentage of the total trade value or a fixed commission amount per trade - PFOF (Payment for Order Flow)
Instead of routing the client’s order directly to an exchange, the broker often rout’s it to a third party and, for that, gets revenue from them - Margin calls
When an investor fails to meet their obligations to pay debts on margin trading, the broker can sell their positions in the market to cover the balance owed, possibly earning a commission in the process.
It’s not hard to notice that none of these methods create a benefit for clients.
The conflict of interests
Remember John? The more active he was on the exchange, the more his broker earned.
That’s why brokers encourage clients to trade more, and they also tend to speculate and impose their investment ideas on clients. It doesn’t help clients to earn more money. Most often, it’s the opposite — they are active, but they are actively losing their capital.
Novice investor trap
Traditional brokers are the majority on the market, so almost all novice investors get in their eager-to-earn-on-your-losses hands.
Lack of knowledge and experience makes novices a perfect target for manipulation.
That’s one of the reasons we don’t recommend them invest in stocks. For those just starting, it’s better to focus on passive long-term strategies of investing in ETFs. You can read more about it in the article we’ve written before.
Regardless of how a broker makes money, its interest usually does not coincide with the client’s interest. Unless it is a fiduciary broker.
What are fiduciary brokers?
A fiduciary broker is an institution obligated to act in the interests of its clients and prohibited from using their funds or information for its own benefit. This approach eliminates the conflict of interest between the broker and the client.
How do they tackle the conflict of interests?
There are two components to achieving the goal of a fiduciary broker:
- It must provide transparent payment terms to clients to receive clear information about the cost of services and investment products.
- It must help clients manage risks and protect their interests in the event of a possible conflict of interest.
To effectively address conflict of interest, fiduciary brokers can leverage Software as a Service (SaaS) — a subscription-based revenue model that promotes transparency in client relationships, identifies and mitigates potential conflicts of interest, and ensures compliance with legal requirements.
Bakksy as the embodiment of a fiduciary broker
Bakksy is the fiduciary broker and investment app for novices that puts clients’ interests and well-being first. We want to bring the idea of a transparent fiduciary broker to life, empowering people with the knowledge and tools they need to make informed investment decisions.
Our long-term goal is to make the fiduciary brokerage model dominant in the market, displace traditional brokers, and force them to transform, always putting clients’ interests first. Because we believe it is the future of the financial market.
About the author
Vasyl Matiy is the Head of investment experience at Bakksy. He has ten years of experience in banking, investment, and asset management. Vasyl is also a portfolio manager of a multi-family office, UHNWI consultant, financial well-being corporate trainer for digital companies, public speaker and columnist.
