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The Ethical Investor: Wall Street Ripoff #11 - Cheating You on Bid/Ask Spreads

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Very few investors bother to check and see what the total fees and costs are that their investment advisor/broker is charging them to manage their money. Even if they ask, they are often told that the services are free or nearly free with the broker forgetting to mention the large expenses paid to third parties like ETF funds, mutual funds and index funds.

If the investor is savvy enough to ask what are the expense ratios of these type investments he uncovers .5% to 2% annual fees, enough to cost him 1/3 to 2/3 of his entire real profits over time. But even these expense ratios do not tell the whole story. Expense ratios do not include transaction costs and one of the largest transaction costs suffered by smaller investors is the bid/ask spread.

Any true securities market works by having market makers who you approach when you want to buy or sell a security. What keeps the transaction fair is that you typically do not disclose whether you want to buy or sell the security in question, but rather just ask for a bid/ask spread. This is really two different prices, the price at which the market maker is willing to buy securities from you, known as the bid, and the slightly higher price at which he is willing to sell you the same securities. It is common for the market maker to know the size of the transaction you contemplate as larger deals typically have smaller bid/ask spreads.

The larger the bid/ask spread, the more it costs you to buy and then sell any one security. Thus, it is a hidden expense of holding and trading securities. In highly sophisticated and liquid markets with very large sophisticated institutional buyers and sellers, this bid/ask spread can get very tight, which is good.

But for smaller individual investors, things are not so good. The investor does not talk to the market maker directly, but works through his broker or salesperson. And salespeople violate the first rule of market making; they tell the market maker in advance whether you are selling or buying. Once the market maker knows this information it is very easy for him to bias his bid/ask spread to make the maximum amount of profit on the trade thus costing you dearly. And, the more turnover or sales in your account, the more bid/ask transaction costs you absorb.

People think stockbrokers are their friends or their golf buddies, but the stockbroker's job is to maximize the amount of assets under management and to always know on every order whether you are a buyer or a seller so they can pass this critical information on to their market makers. It should be criminal, but then again, much of what goes on on Wall Street should be labeled so.

In the future, when you want to buy or sell a security, don't tell your broker your intention, just ask for a bid/ask spread. Then compare this bid/ask spread with quotes from other brokers and published sources online. Make sure the absolute difference is reasonable as a percentage of the security's price and that they haven't biased the quote in one direction or the other.

If anyone tells you they are managing your money for free with no fees attached, run, do not walk to the nearest exit.

20 Ways Wall Street is Ripping Off Small Investors

  1. Providing nominal returns, not real returns.
  2. Encouraging too much diversification, if that's possible.
  3. Hiding fees and expenses.
  4. Turning you into a passive investor.
  5. Convincing you that money markets are the same as cash.
  6. Telling you that bonds are safer than equities.
  7. Explaining that in the long run equities outperform bonds.
  8. Simply by lying about their products.
  9. Convincing you that their bank is a large, stable, safe operation to deal with.
  10. Recommending products that have enormous sales commissions attached to them.
  11. Cheating you on bid/ask spreads.
  12. Selling you what they don't want.
  13. Measuring your success in dollars.
  14. Lending your securities to others.
  15. Ripping your eyes out if you ever try to close your account.
  16. Grabbing any slight positive real return for themselves.
  17. Sticking toxic waste to small investors.
  18. Pretending they can pick stocks.
  19. Acting like they are your best friend and they have your best interests at heart.
  20. Knowing next to nothing about the value of holding real assets like gold and real estate.

John R. Talbott is a bestselling author and financial consultant to families whose books predicted the housing crash, the banking crisis and the global economic collapse. You can read more about his books, the accuracy of his predictions and his financial consulting activities at www.stopthelying.com.

Content concerning financial matters, trading or investments is for informational purposes only and should not be relied upon in making financial, trading or investment decisions.