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broker dealer

A broker-dealer is one of the most important people or firms you’ll work with as you invest your money. Broker-dealers are the professionals who buy and sell securities for clients while building their own portfolios. Many of your investments will be made through broker-dealers, and you’ll be paying them to do it. Knowing what broker-dealers do, how you’ll be paying them for their services and any potential conflicts of interest is important. It ensures you’re building your portfolio in the most efficient way possible.

What Does a Broker-Dealer Do?

Broker-dealers are essential for securities sales. Broker-dealers can be companies or firms, or individual people. And as you may be able to guess from the hyphenated name, they can serve two distinct roles.

Sometimes they act as a broker. This means they help you buy or sell a security, like a stock. As a middleman, they help you buy the shares from whomever is selling them, and in return you pay a brokerage fee.

They can also act as a dealer. (Note that according to the Securities and Exchange Commission (SEC), a dealer is different from a trader.) This means they are actual participants in the sale, actively buying or selling the security in a deal with an investor. This is how broker-dealer firms build their own portfolios. Here, the broker-dealers will make sure to sell the security for more than they paid for it, earning money for their firm’s account. Broker-dealers must disclose to clients when they are acting as a principal in a transaction.

You may end up working with a broker-dealer in both of these situations as you continue to invest and build your portfolio. There are, generally speaking, two types of broker-dealers. One is a wirehouse. A wirehouse is a larger, full-service brokerage that sells its own products to consumers. While there are many wirehouses, four of the biggest and most popular in the U.S. are Morgan Stanley, Bank of America Merrill Lynch, UBS and Wells Fargo.

The other type of broker-dealer is an independent broker-dealer, which is more like an independent contractor. Independent broker-dealers only sell outside products to customers.

How Do Broker-Dealers Make Money?

broker dealer

One of the main ways broker-dealers make money is through brokerage fees. These are fees charged for executing trades for clients. A brokerage fee can be calculated in a few different ways. Some fees are a flat fee per transaction. Others are a percentage of total sales. Some fees are a mix of the two.

The amount you pay will also depend on the type of broker-dealer you use. A full-service broker will have large number of services available and will generally charge between 1% to 2% of the money involved in a trade. Discount and online brokerages have much lower brokerage fees, oftentimes charging flat rates of between $5 and $30 for each trade.

On the “dealer” side of the equation, a broker-dealer makes a profit from what’s called the bid-ask spread. This follows the same logic of how any business makes money. A broker-dealer buys securities, such as bonds and stocks. They then sell the securities to another investor at a price higher than the buying price. The difference between the two prices is known as the dealer’s spread, and it represents the profit that the broker-dealer makes on the transactions.

Broker-Dealers and Conflicts of Interest

broker dealer

Sometimes your financial advisor will also serve as your broker-dealer. This has advantages and disadvantages.

A big plus is simplicity. You won’t need to work with multiple financial professionals, which means that much of the administrative aspects of managing your investments can be streamlined. This is especially convenient if you think you’ll be making a lot of securities transactions.

However, there is potential for this arrangement to represent a conflict of interest. Remember, you’ll be paying your financial advisor a fee for their wealth advisory services, generally based on a percentage of assets under management (AUM). If the advisor is also your broker-dealer, though, you’ll have to pay them more if they execute more trades for you or even sell you their own securities in their role as  a broker-dealer. It is smart to pay attention to how much money your advisor will potentially charge you as someone who is also your broker-dealer.

The Bottom Line

A broker-dealer is a person or a firm that works with individual investors who want to buy and sell securities. They can act as both a broker and as a dealer. When acting as broker, they are a middleman for transactions between two different investors exchanging a security. When acting as dealer, they are active participants in the deal, either buying or selling a security for their own accounts. Your wealth advisor may also serve as your broker-dealer, but this brings a potential conflict of interest you should be aware of.

Investment Tips

  • If you’re ready to start investing, a good place to start is by finding a financial advisor. SmartAsset can help with our free financial advisor matching service. Just answer a few questions and we’ll match you with up to three advisors in your area. We fully vet our advisors and they are free of disclosures. You talk to each advisor to ask any questions, then make a decision about how you want to move forward.
  • Curious how the buying power of your money will change over time? Use SmartAsset’s free inflation calculator to see the project impacts of inflation.

Photo credit: ©iStock.com/gorodenkoff, ©iStock.com/jacoblund, ©iStock.com/FlamingoImage

Ben Geier, CEPF® Ben Geier is an experienced financial writer currently serving as a retirement and investing expert at SmartAsset. His work has appeared on Fortune, Mic.com and CNNMoney. Ben is a graduate of Northwestern University and a part-time student at the City University of New York Graduate Center. He is a member of the Society for Advancing Business Editing and Writing. When he isn’t helping people understand their finances, Ben likes watching hockey, listening to music and experimenting in the kitchen. Originally from Alexandria, VA, he now lives in Brooklyn with his wife.
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