Tuesday, October 1st, 2013 @ 3:55PM

By Dennis Miller

When my father-in-law died, my wife and I took over the responsibility of looking after her mother, who I affectionately called “grandma.” We quickly connected with a very nice lady who was a broker at one of the top brokerage firms in the country.

Over time she became a mentor, advisor, and friend. Although she’s been retired for quite some time, we’re still in contact and are very close. If I were to pick one attribute that sets her apart, it would be honesty. Ask her a tough question and she’ll give you a straight answer, even though it may cost her some money.

Around the time that many of the online discount brokerage firms were emerging, our broker put in a trade where we sold 1,000 shares of a stock at $24/share, so the trade was $24,000.00. When we got the transaction sheet in the mail, there were some small fees, but her firm took a $240 commission just for handling the transaction. I called and asked her how the firm justified those fees to its clients. We were being bombarded with television commercials, letters, and flyers from discount brokers who would handle the transaction for only $19.95. Basically, I asked her what the extra $220 in commissions bought us.

She was very straightforward, and it was apparent I was not the first client to ask. She said that she cut the commission to rock bottom, meaning there was no lower fee structure available, and then went on to explain that discount brokers were merely transactional brokers with no research departments and no advice. They just processed transactions. By contrast, her firm had all these high-priced folks in New York who did tons of research and analysis and provided advice and guidance.

I then (with her help) wrote a letter stating that I was toying with making an investment in a particular market but wasn’t quite sure if the sector made sense – and if it did, what particular stock would be the best choice? She took my letter, put her cover letter on top of it, and sent it to her firm’s gurus in New York.

A short time later, we got back a 2-3 page report discussing the sector and recommending a particular company to invest in. They recommended it as a “strong buy” simply because 8 of 10 major firms recommended the company as a “buy or strong buy.” Other than the standard information about growth, P/E ratios etc., there was really not a whole lot of support behind why the particular stock was supposedly so appealing.

Honestly, I went nuts when I read the report, because simply saying that 8 of 10 major firms recommended something was not research. Actually, it was an admission of delegating the research to some other firm and then hoping it did it right. Perhaps that was why the P/E ratio was so ridiculously high; the investing guru Benjamin Graham would have been telling his clients to sell the same stock.

So I asked our broker, “What happens if some researcher gets a tip from his barber on a stock, then he goes to the office and recommends it as a ‘buy.’ Then another firm picks up on it and also recommends it, and pretty soon 8 of 10 recommend it. That alone would drive up the price of the stock, but who actually did any research?” She grinned and mentioned something about the integrity of the individual doing the job.

When I wrote the letter, I’d wanted someone to do the type of research Benjamin Graham discussed in The Intelligent Investor. I wanted them to find a stock that’s not on anyone else’s list with a P/E that was within reasonable guidelines. Heck, by the time 8 of 10 major firms have rated it as a “buy or strong buy,” it’s too late. At that point Graham and his clients would be taking their profits. In today’s lingo, the Casey group would have recommended you sell at least half of it and perhaps retain some of the investment as a “free ride.”

Not long after that, our friend retired, and I switched the family accounts to a discount online broker. As I was surfing its website, I noticed a “Research” tab. I clicked on it and typed in the symbol of the stock, and up popped several available reports and a one-page summary. I realized then that what we got from the high-priced, old-line brokerage firm was not much different than the summary that had just popped up on my computer screen.

Sad to say, some of the things that I’ve seen passed off as research are like sugar-free Jell-O topped with fat-free Cool Whip; it has the illusion of substance… but not much else.

For the next several years, what little I had for research I did through the search engine of my online broker. It was boring, tedious, and time-consuming. Perhaps like some other investors, I wanted to find an easy way out.

At that time I was subscribing to several investment newsletters that all touted their research and weren’t shy about making specific investment recommendations, something the discount brokers stayed away from at the time. Some did their job better than others.

For close to a decade I didn’t use investment services because we had most of our portfolio in CDs. It wasn’t until my wife and I began to actively self-manage our portfolio that we started subscribing to highly-specialized newsletters. These newsletters had true experts in a particular sector or investment type doing the research and making the recommendations. This isn’t meant to be a shameless plug, but I read a couple of the Casey newsletters like BIG GOLD, where there are folks on the ground, photos of the various mines, backgrounds, and where the author had known the principals for a couple decades. I was impressed. I’d never read any of this kind of stuff sifting through information from my discount broker, nor had I seen this level of detail from the so-called “full-service” brokers.

By comparison, I saw recommendations for companies I had never heard of and never saw references to any other firm or service making those recommendations.

In an edition of The Intelligent Investor, there’s an article in the appendix  in which the author tracked the career of five folks trained by Benjamin Graham. Each went out on his own, applied the techniques he was taught and over time put together a portfolio that made him and his clients very wealthy. However, there was almost zero overlap between those portfolios. Each had used the Graham criteria – but found his own recommendations. If 8 of 10 major firms recommended a given stock as a “buy or strong buy,” they all would have passed it over and moved on.

It makes sense to do your due diligence on the companies you invest in. But you should also understand the motivations and incentives driving your gurus, your subscription financial-services providers, and your newsletter authors. Some financial research involves picks that are paid for by the companies being recommended. That’s not the case at Money Forever, but for a long time I was naïve enough to believe that all subscription-based financial newsletters were only compensated by their subscribers. How silly of me! Now I read the small print at the end of the newsletters very closely.

Posted by AIA Research & Editorial Staff
Categories: AIA Newsletter