How to Evaluate the Health of Your Brokerage Firm

by Kevin on November 6, 2012

I recently posed a question: should I diversify my brokerage firms? In other words, much like your investments need diversification, does it make sense to spread out the risk of your brokerage firm failing by having multiple places that you invest your money?

Maggie from Square Pennies asked this question:

Diversifying risk is always a good idea. Having 2 brokers ought to be enough. Is there some way to investigate how secure a brokerage’s finances are? Thanks!

This is a great question, but instead of replying back in comment form I thought it made more sense to write an article in response.

How Healthy is My Investment Broker?

Having your brokerage firm go bankrupt is at best an inconvenience. For someone that is heavily reliant on the funds invested in the account (perhaps a retiree with income checks coming in each month) it can be absolutely devastating. As I mentioned in the previous article you want to make sure your brokerage firm is a member of SIPC, but that is just a starting point. Having SIPC protection means you will eventually get your investments back, but you never know how long that will take.

Just like any other organization, a brokerage firm has an income statement and balance sheet. Ideally you could get access to these, but if it isn’t a publicly traded company then that can be more difficult. At the end of the day the more information you can get on the finances and reputation of the firm, the better off you are.

Resources to Check Financial Health of Brokerage Firm

If your brokerage firm is publicly traded, simply use a stock website that will give you access to the balance sheet and income statement. Google Finance is one of many sites you can use to pull up these financial documents. (In other words, there is no need to pay for access to a company’s financials.)

The next place to look is FINRA’s Broker Check service. FINRA is the Financial Regulatory Authority, an independent regulator of security firms in the United States. The Broker Check service will show you any negative reports on the firms or specific individual brokers including late debts and criminal activity.

You should want your broker to be in the Broker Check service because it means they are registered with FINRA because it means the regulators have looked at the company in depth.

Although they may not give you what you want, you can always ask the brokerage firm for a statement of financial health.

When You Should Be Cautious

Most brokers that you see advertised on TV, in print, on the radio, and so forth are mostly reputable. Companies like Scottrade, E*TRADE, and Vanguard are all legitimate firms that you should feel pretty good about having an account with. Still do your research, but these are large reputable firms.

Where you need to be really careful is when someone is promising extraordinary returns to you. If a supposed broker — especially one not registered with FINRA — says they can offer you an investment to give you a consistent 14% return, be very, very careful.

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