What does a broker do?

What is a Broker?

A broker is a person or company that serves as a go-between for an investor and a securities exchange. Since securities exchanges only accept orders from their members, individual traders and investors require the assistance of these members to conduct trades.

Brokers offer this essential service and earn their compensation through commissions, fees, or payments from the exchange. Investopedia frequently evaluates leading brokers and curates a list of the best online brokers and trading platforms to assist investors in choosing the right broker for their needs.

Understanding Brokers

In addition to carrying out client orders, brokers often offer investors research, investment strategies, and market insights. They might also promote other financial products and services from their brokerage firm, such as exclusive client services that deliver customized solutions for high net worth individuals.

Historically, only the wealthy could afford the services of a broker to access the stock market. However, the advent of online brokerage has led to a surge in discount brokers, enabling investors to trade at reduced costs, though without the benefit of personalized advice.

Discount vs. Full-Service Brokers

Discount brokers facilitate various types of trades for clients, typically charging minimal or no commissions. Their fee structure is low due to high trading volume and reduced operational costs. They do not provide investment advice, and their brokers usually earn a salary rather than commissions. Most discount brokers feature an online trading platform that appeals to a growing segment of self-directed investors, often offering commission-free trades.

Full-service brokers, on the other hand, provide a wide array of services, including market research, investment advice, and retirement planning, alongside a comprehensive range of investment products. In exchange, investors pay higher commissions on their trades. These brokers are compensated by the brokerage firm based on trading volume and the sale of investment products. Increasingly, brokers are offering fee-based investment options, such as managed investment accounts.

Broker Regulation

Securities brokers must register with the Financial Industry Regulatory Authority (FINRA), the self-regulatory body for broker-dealers. They are required to adhere to the "suitability rule," which mandates that brokers have reasonable grounds for recommending specific products or investments. This rule includes the "know your customer" (KYC) component, which requires brokers to identify their clients and understand their savings goals to make appropriate recommendations.

Brokers must make a reasonable effort to gather information about the customer's financial status, tax status, investment objectives, and other relevant details for making suitable recommendations.

This conduct standard is different from the one for financial advisors registered with the Securities and Exchange Commission (SEC) as registered investment advisors (RIAs). RIAs are held to a fiduciary standard under the Investment Advisers Act of 1940, which obligates them to always act in the best interest of their clients and fully disclose their fees.

In the U.S., real estate brokers are licensed at the state level rather than the federal level. Each state has its own regulations that define the relationships between clients and brokers and the responsibilities brokers have to clients and the public.

Examples of Brokers

Full-service brokers often offer brokerage services as part of a broader suite of services for high-net-worth clients, which can include retirement planning and asset management. Companies like Morgan Stanley, Goldman Sachs, and Bank of America Merrill Lynch are examples of full-service brokers.

Larger brokerage firms typically maintain an inventory of shares available for sale to their clients. This practice helps reduce exchange fees and allows for quick access to popular stocks. Some full-service brokers operate as agency brokers, meaning they do not maintain an inventory of shares but act as agents to secure the best trade executions for their clients.

For instance, if a high-net-worth investor named Amy wants to place a large buy order for Tesla Inc. (TSLA) stock, she would contact her broker to execute the order for 10,000 shares. With an order exceeding $1 million, Amy prefers having a broker handle the trade directly. The broker receives the order and, if the brokerage has the shares in inventory, they will likely fulfill Amy's order immediately. If not, they will purchase the shares from exchanges or other brokerages, possibly acquiring 500 to 1,000 shares at a time to complete the order after funds settle.

What Does a Broker Do?

A broker acts as an intermediary, facilitating trades between individuals or companies and the exchanges where they are licensed. Depending on the trade and marketplace, brokers can either be humans processing the trades themselves or computer programs overseen by humans. Typically, stock trades are handled by computerized systems, whereas trades in areas like real estate require a more personal touch.

Do Brokers Make Money?

Yes, brokers do make money. Their earnings depend on several factors, primarily the value of the clients they serve or if they work with businesses such as commercial real estate owners and sellers. A typical stockbroker may earn a salary and commission on managed trades, with an average salary of about $160,450 as of April 2024.

What Is a Broker and Why Do I Need One?

A broker serves as a middleman between individuals looking to trade and invest and the exchanges where these trades occur. You need a broker because stock exchanges mandate that trades be executed by licensed individuals or firms. Additionally, brokers facilitate a seamless trading experience between investors and exchanges. Discount brokers, in particular, often do not charge commissions for standard trades, making the process more cost-effective.

How Do You Become a Broker?

To become a broker, having a background or degree in finance or economics is highly advantageous. While this can help you get noticed by potential employers, you must also obtain the necessary licenses to be hired and work as a broker.

The Bottom Line

Brokers earn a good salary, spending their days facilitating smooth transactions between clients and exchanges. Although brokers can manually execute trades, they typically monitor them from computers and only intervene for exceptionally large or unique transactions.