Are Brokers and Financial Advisors Ripping You Off?

With more than three decades' worth of his annual letters to Berkshire Hathaway (NYS: BRK.A) (NYS: BRK.B) shareholders posted on Berkshire's website, there are plenty of great Warren Buffett stories to choose from. But one of my personal favorites from the Buffett archives is his parable of the Gotrocks family.

Meet the Gotrocks
Buffett first told the Gotrocks story in the 2005 shareholders' letter (PDF file, Adobe Acrobat required) under the heading "How to Minimize Investment Returns." And who, exactly, are the Gotrocks? They're a fictional family that owns every American corporation -- thousands of companies that annually earn (as of 2005) around $700 billion. It's a pretty sweet setup for the Gotrocks clan.

But the Gotrocks family's investment life doesn't remain tranquil. Here's Buffett:

[L]et's now assume that a few fast-talking Helpers approach the family and persuade each of its members to try to outsmart his relatives by buying certain of their holdings and selling them certain others. The Helpers - for a fee, of course - obligingly agree to handle these transactions. The Gotrocks still own all of corporate America; the trades just rearrange who owns what. So the family's annual gain in wealth diminishes, equaling the earnings of American business minus commissions paid. The more that family members trade, the smaller their share of the pie and the larger the slice received by the Helpers. This fact is not lost upon these broker-Helpers: Activity is their friend and, in a wide variety of ways, they urge it on.

The problems don't end there, because soon a second class of Helpers enters the picture:

"Hire a manager -- yes, us -- and get the job done professionally." These manager-Helpers continue to use the broker-Helpers to execute trades; the managers may even increase their activity so as to permit the brokers to prosper still more. Overall, a bigger slice of the pie now goes to the two classes of Helpers.

It doesn't end there. The hapless Gotrocks are inundated with one layer of Helpers after another, each taking their cut. The joke, of course, is on the Gotrocks, because the maximum income they can receive will always be the total income of all the companies that they own, but they end up further and further from that maximum as they pay ever more fees to the Helpers.

Helping is big business
Helping (in Buffett's sense) is a massive industry. Thanks in large part to the acquisition of Merrill Lynch and its "thundering herd" of brokers, Bank of America's (NYS: BAC) wealth management division is gigantic. It brought in more than $17 billion in total revenue in 2011 and earned the bank $1.6 billion in net income. Wells Fargo's (NYS: WFC) brokerage clients house $1.1 trillion at the bank and it ended up with $1.3 billion in profits from that division in 2011 on $12.2 billion in revenue.

And those are just a couple of the big boys. They're joined by other giants such as UBS and Morgan Stanley Smith Barney, as well as legions of smaller companies and independent advisors.

Take, take, take?
In a technical sense, Buffett is 100% correct -- for every penny that brokers and financial advisors take, we, as a whole, earn less. (You got that we're the Gotrocks, right?)

But does the story end there? Are brokers and financial advisors simply fast-talking financial-industry leeches, eagerly sucking the green out of our portfolios? Or is there legitimate value being added by brokers and advisors?

I want to hear what you have to say. Whether you're a financial advisor or broker yourself, or you're a customer who's worked with a financial advisor or broker, I want to hear your story. Send an email to tips@fool.com or scroll down and tell us your thoughts in the comments section below.

At the time this article was published The Motley Fool owns shares of Bank of America and Berkshire Hathaway. The Fool owns shares of and has created a covered strangle position in Wells Fargo. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.Fool contributor Matt Koppenheffer owns shares of Bank of America, Morgan Stanley, and Berkshire Hathaway, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.

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jdykbpl45

Only Obama, Bernake, Pelosi, Reid, Corzine and Timmy ( Tax Ch eat) Geithner. How can you trust them?

March 09 2012 at 6:42 PM Report abuse rate up rate down Reply
jdykbpl45

No. Obama, Pelosi, Reid, Bernake, and Geithner are. There is no insurance fund to cover these.

March 09 2012 at 6:38 PM Report abuse +1 rate up rate down Reply