Brokers vs. Money Managers

At Jalex Trading, we believe it’s important for investors to understand the difference between brokers and professional money managers.  The distinctions between the two could make a significant difference in the long term performance of an investment.

A Quick Note…The following examination of some of the differences between Brokers and money managers relates primarily to potential trading performance.  This examination does not address some of the other reasons why you might choose to open a  trading account.  If your motivation for opening a trading account is to get the “adrenaline rush” that’s often associated with speculation, you should do business with a  Broker (and not a money manager).  Simply stated, you won’t find “trading thrills” by investing in a managed trading program under the direction of a money manager.  On the other hand, if you’re primarily concerned with the long term performance potential of your investment  then we encourage you to carefully consider the following:

Brokers – Most of us understand the activities of a broker.  Brokers solicit investors to open trading accounts and then work with the their clients (usually each trading day) to determine what they hope will be profitable trading strategies.  Brokers are compensated when their clients execute trades.  We’ll say that again because it’s important….Brokers are compensated when their clients execute trades.  The profitability of those trades has nothing to do with how much the brokers is paid.  For a Broker, commissions are a primary source of personal income.

Undoubtedly, all brokers want their clients to be profitable. After all, when a client earns profits he/she continues to trade and that results in more commission income for the broker. The ultimate question is whether a relationship with a Broker will provide the greatest opportunity for  long-term successful performance.

Professional Money Managers –  The role of a professional money manager  is to direct the trading activity for the benefit of their clients.  In many cases (it’s true in our case), money managers don’t receive any of the commissions generated by client trades. Instead, they typically receive a management fee (a percentage of the total equity in the client account) and incentive fees (a portion of the new net profits the client earns).  Since money managers have the potential to earn incentive fees, they are naturally motivated to earn profits for their clients.  Of course, that motivation is no guarantee that the money manager will in fact earn profits in their trading  

With a sizable portion of their potential compensation (incentive fees) linked to profitability, most professional money managers view commissions as a cost of doing business.   To a money manager, commissions are merely a “drag” on profits. Since commissions are an expense that reduces profits, it’s in the money manager’s best interests to minimize commission costs.  That’s in direct contrast to the motives of a Broker. 

For a money manager that receives compensation based on incentive fees, LOWER commission costs increase the incentive fees the money manager may earn.  Naturally, greater profits translates to more earnings for the client and a bigger paycheck for the money manager.  For a Broker, higher commission costs are needed to earn a bigger paycheck. 

Trading Performance Of Brokers and Money Managers

If you are considering an investment, it’s important to evaluate what type of relationship (a relationship with a Broker or with a Money Manager) will give you the optimal chance for success. How do you go about this evaluation process?  One way is to evaluate the trading performance of both the Broker and the money manager

As you consider the trading performance history of a Broker or money manager, remember that past performance is not necessarily indicative of future results. 

Trading Performance of the Broker - If you’re considering a relationship with a Broker, ask the Broker to provide you with a performance history of the trading recommendations he/she has given to clients.  The performance history should be put together in a format that’s consistent with “industry standards” , defining the profits/losses from trades, commission costs and any other costs associated with executing the trades or maintaining the trading account.  It would be best if this performance history has been “audited”, or at least reviewed by an accountant.  If the Broker provides you with this type of performance history, you’ll be better able to objectively determine what the Broker can do for you. If the Broker is unable to provide this information, that should weigh into your relationship-selection process.

Trading Performance of the Money Manager -If you’re considering a relationship with a Money Manager, in most cases you will receive a copy of their Disclosure Document.   This document contains the manager’s performance history, providing information regarding the manager’s trading program, the fees your account will be charged, performance histories, risk disclosures, etc.  With this information in-hand, you will be able to better equipped to decide which relationship is best for you.