Financial services are a mysterious and puzzling world to many investors because their own language surrounds them. Terms like alpha, beta, and Sharpe ratio don't exactly slide off the tongue, and their usage by industry insiders doesn't help to raise the curtain and make things more transparent. Of course, the terminology is appropriate for the medium since the financial services industry is a sophisticated one. When it comes to investing in that world, it's essential to understand the phrases brokers and dealers use to get started. Let's look at the distinction between brokers and dealers.
What Is a Financial Broker Dealer?
Broker-dealers are companies that purchase and sell securities such as stocks, bonds, and mutual funds on behalf of their clients. Broker-dealers play a significant role in the financial markets since they offer the infrastructure that allows stock trading to take place. In reality, in order to purchase stock, you must first create a brokerage account with a brokerage company. The brokerage business ensures that you have enough money in your account to complete a transaction, facilitates the deal by communicating with the stock exchange where the stock is exchanged, provides the computer systems that execute the trade, and maintains trade records.
What Is the Role of a Financial Broker Dealer?
Financial Broker dealers, who are necessary to maintain the market liquid, might be companies, institutions, or individuals. And, as you would expect from the hyphenated name, they perform two unique functions. They may function as a middleman. This implies they assist customers in purchasing or selling a security, such as a stock. They act as a middleman, assisting you in purchasing shares from whoever is selling them in exchange for a brokerage fee.
At times, they take on the role of a dealer. This implies that they are active participants or even principals in the selling of securities. (It is important to note that traders purchase and sell for themselves – not as part of an average company.) This is how brokers assist in keeping markets liquid (by taking securities on their books before finding purchasers) while also building their holdings. Broker-dealers will ensure that the stakes are sold for more than they were paid for, making money for their firm's account. Broker-dealers are required to inform customers when they are acting as the principal in a transaction.
Broker-Dealers: How Do They Make Money?
Brokerage fees are a significant source of revenue for financial broker dealers. These are the costs charged for executing transactions on behalf of customers. A brokerage fee may be computed in a variety of ways. Some fees are set on a per-transaction basis. Others are calculated as a proportion of overall sales. Some fees are a combination of the two. The fee you pay will also be determined by the sort of broker-dealer you select. A full-service broker will provide a wide range of services and typically charge between 1% and 2% of the amount involved in a deal. Discount and internet brokerages have substantially cheaper brokerage costs, sometimes offering flat rates ranging from $0 to $30 for each transaction.
A broker-dealer profited from the bid-ask spread on the "dealer" side of the equation. This follows the same rationale as any other company. A broker-dealer is someone who buys securities such as bonds and stocks. They then sell the shares to another investor at a price more significant than the one at which they purchased them. The difference in the two prices is referred to as the dealer's spread, and it indicates the profit made by the broker-dealer on the transactions.
Conflicts of Interest and Broker-Dealers
Until recently, significant financial broker dealers were usually associated with financial advisory businesses. This helped to keep the various functions distinct and reduce any conflicts of interest. Your adviser suggests that you purchase a stock; you agree, and your advisor places the order with their linked broker-dealer. Your adviser is solely compensated for providing sound advice, whereas the broker-dealer is compensated for executing the transaction.
However, more and more broker-dealers are also registering as investment advisers. Or, as registered agents of broker-dealers, financial advisors operate. This simplifies their operations but makes it more difficult for consumers to determine if their adviser is serving as a fiduciary (as required of investment advisors) or as a broker. Your adviser advises you to purchase a stock, but is he acting as your advisor, who is looking out for your best interests, or as your broker? The only way to be sure is to ask.
Conclusion
Most people associate brokerage with a financial broker dealers. It operates as a go-between for buyers and sellers of securities. When a company buys or sells for its own account, the dealer role comes into play. While your financial adviser may also act as your broker-dealer, this creates a possible conflict of interest.
