For most Indian retail investors, equity markets have remained an enigma (read: confusion) for a long time now. Successive scams and misdeeds over the last decade have left investors in the lurch. Not surprisingly, the percentage of household savings invested in equity and related instruments has declined sharply in the last decade.
Among various market participants, brokers play a very vital role as a financial intermediary. More often than not, brokers are the first contact point for retail investors when it comes to investing in the stock market.
While it can be safely said that brokers have been, to an extent, responsible for the poor image of the stock markets in the eyes of the investors, it would be unwise to put all the blame on them.
As much as stock selection is a systematic and an extremely essential aspect to equity investing, so is choosing the right broker. Investors have to realise that brokers are just intermediaries and the final decision to buy or sell a stock is in the hands of an investor himself.
Problems arise when the investor depends significantly on the broker, not just to execute the transaction, i.e. buying or selling shares, but also to provide investment advice.
Blind faith in the broker can be harmful for the investor simply because, whether the investor gains from the buying or selling decision or not, the broker is sure of the brokerage. Therefore, investors have to ensure that they know their brokers well and understand their advantages and shortcomings.
In this article we try to bring out a checklist, which will help the retail investor to wisely choose a broker who can cater to all his needs.
One of the foremost criteria for selecting a broker has to be the broker's financial health. In the past, many investors have been left in the lurch as brokers have wound up due to financial difficulties (margin lending beyond limits combined with other stock market related issues).
Investors need to find out the financial health of the broker in order to ascertain how safe their dealings are. The investor can ask your broker for his latest audited net worth as submitted to the stock exchange.
The higher it is the better. It means that the broker has committed higher amounts of capital to his business and thus stands much more to lose if he violates the law.
Investors need to keep themselves away from brokers that have a tainted past as far as their dealings on the stock markets are concerned. Many a broker have been involved in scams and investors need to realise that more often than not, it is their money and shares that gets misused in these wrong doings.
The track record of a broker is of prime importance. The investor can ask to see their register of investor complaints that the broker is required to maintain statutorily.
If the broker does not have such a register then it is better to avoid such a broker. The investor should also ask the broker upfront if he or the broking entity has any outstanding cases of arbitration or legal proceedings pending against them by the Securities and Exchange Board of India or the stock exchange.
Fast and accurate order execution is another key criteria to choose a broker. Every broker competes to render such service, as customer satisfaction will bring more business and trading volumes. Investors should select a broker with a sufficient number of marketing officers and telephone lines to handle the orders.
One also needs to find out whether the broker has an online presence or interface that lets clients trade through the Internet. If yes, then it does not mater where his office is. Or else, you would want to select a broker closer to your place of work or residence Ease of accessibility is important.
Documentation and after-sales services: Documentation is vital since it represents the formal contract between you and your broker. It is advisable to have a copy of any document the investor signs.
As for as after-sales services are concerned, a number of brokers are now using automatic account clearing and transfer. This requires flawless, easy-to-understand documentation that can be checked at all times.
Investors also need to find out whether the broker has his own depository participant services, this will greatly simplify the procedure for transfer of shares in case of a sale transaction for delivery.
For the retail investor, information, primarily in the form of research (on companies as well as sectors) is of prime importance. At the same time it is even more important that the research is unbaised. While we are not implying that broker research is not unbiased, it is better that investors rely on research provided by an independent entity (that is available with the broker) in order to avoid any occurrences of conflict of interest.
Remember that no matter what the research information says you must exercise your own judgement or research the stock some more on your own. Try and read at least more than one point of view on any stock or sector.
Another critical factor is to understand where the broker is sourcing its research from, if it does not have its won research desk. Remember, the more you trade, the more the broker benefits.
Retail investors and we reiterate, the term 'investors' do not need to be too bothered about brokerage fees or other fees. For instance, there are essentially five types of charges and fees -- that you pay the broker, the DP, the stock exchange, the state govt and the central govt. i.e. brokerage (goes to the broker), annual demat maintenance charges, transaction charges and demat custodial charges (goes to the depository participant and partly to the depository i.e. NSDL or CDSL), transaction fees (goes to the stock exchange), service tax on brokerage, stamp duty and now education cess (all go to the state and central government).
If one isn't trading in and out of stocks very often, and if you're not too concerned about whether your trade is executed within 15 seconds or 2 minutes, there really isn't a significant difference among brokers as far as fees and other charges are concerned.
Investors also need to be informed about the affiliation of the broker with the various exchanges. While most brokers have membership with the two largest exchanges in the country, namely NSE and BSE, some of them do not have both these memberships. This is an important aspect, as certain stocks are listed on only one exchange (like Castrol and Nestle).
Some brokers, apart from equities, also provide services like mutual funds advisory, insurance and fixed income schemes.
However, a word of caution investors need to be aware of the background of the broker as far as selling and distribution of specialised products like mutual funds and insurance is concerned.
Advice regarding asset allocation is an extremely specialised field and your broker may or may not have the necessary skill set to provide such services. If the broker is giving you such a service then try and see if the staff is qualified by IRDA for insurance or by AMFI for mutual fund products or by AFP for financial planning.
Again, irrespective of whether you make money, the broker is sure of his commission.
Ask your broker if he does proprietary trading. What percentage of his total business is made up of proprietary trading? The higher it is the more it is of concern. Simply because the brokers efforts are also being invested in managing his own portfolio (either investments or trading or both) and he probably has less time or interest in servicing you.
The larger his proprietary trading is then it is more likely his own interest may come first and not yours. You can ask for systems and procedures that they have in place for clearly segregating the two.
A good professional broker may do some proprietary trading but would definitely have good systems to clearly segregate the two. (e.g. physically separate dealing rooms, different trader work stations and a separate dealing team).
Corporate brokers are preferable over partnership or sole proprietary concerns. You have recourse to them under company law other than other capital market regulations. They also have to meet higher minimum net worth criteria to become a member of an exchange.
Investors, i.e. people with an investment horizon of atleast one year and above, need to understand that a broker is just an intermediary and the decision to invest or otherwise is in their hands.
It is important to understand that it is not always prudent to blame the broker for your losses though that is often the easiest thing to do!
Equitymaster.com is one of India's premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.
