If you’ve been reading this magazine long enough, you’ll know that we hardsell the concept of long-term, fundamentals-based investing. It’s something any responsible financial advisor will do. But most brokers are something else altogether. Anyone who has had anything to do with the stock market will remember December 2007. That was when brokers could not recommend Reliance Petroleum strongly enough, despite the company not being entirely worthy of such focused bullishness.

But, largely due to broker’s enthusiasm, people started buying. Then the promoter offloaded his 5% stake in the company for around Rs 275 a share and the stock started slipping. It eventually hit a low of Rs 110, eroding crores of rupees of small investors’ wealth.

Aarti and Vinod Arora, 38 and 45 Delhi The case Since the Aroras were too busy to monitor their investments, they accepted a relationship manager’s offer to handle their stocks portfolio. He pushed them into the buy-sell routine and introduced them to margin trading, futures and options. By January 2008, the Aroras had around Rs 1 crore invested in the stock market, a chunk of it in leveraged positions The mis- selling The relationship manager did not explain the extent of risk involved in margin trading. Worse, when markets crashed and the margin calls star ted coming in, he went against his clients’ directive not to sell and squared off their purchases The mistake The Aroras let themselves believe that things would not go belly-up and committed vast sums of money against their better instincts The damage In the stock market crash in January, the Aroras lost Rs 58 lakh Up to 5 times his salary is the brokerage that a relationship manager has to generate

Relationship managers and brokers quickly forget the fundamentals of risk management and prudent investing because it is the investor’s money at risk, not theirs. They play on the greed of the investor, telling him how his money can double or more, without explaining the risks that will have to be taken for this growth to happen. That’s because brokers don’t get a commission on the profit you make; they get a commission on the number of times you trade. Heightened competition has reduced brokerage charges to 0.3-0.75%.

The only way to profit is by making clients trade more often. If clients feel constrained because they don’t have enough funds, brokers induce them to do intra-day trades, and readily lend them the margin trade amount. It’s a high-risk game, where you are usually not told the rules. Whether or not you win the game, the broker earns interest on the margin and a commission every time you buy or sell.

The good news is that not all brokers and relationship managers are as unscrupulous. “Nobody loves a buy-andhold investor in a brokerage house,” says Shantanu Chatterjee, who used to work as a relationship manager with a large broking house till last year. Chatterjee used to advise clients to pick up value stocks and steer clear of momentum scrips. He told them to keep the stocks locked up in their demat accounts for the long term and to never even think of entering the high-risk area of margin trading and futures and options. And then he had to leave, as his advice was contrary to the goals of his employers.

Had Delhi-based Aarti and Vinod Arora found a manager like Chatterjee, they might be richer by Rs 58 lakh today. But the sad fact is that as long as the existing commission structure is in place, brokers are not going to take kindly to encouraging buyand-hold investors. If they are to stay in the business, they need day-traders and investors willing to risk their shirts in intraday trading.

As long as they explain the risks involved in such trading to the investor, and the investor understands and accepts these risks, all is well. The minute the broker hides vital facts and pretends that this is the only way to make any profit, he has crossed the line from being a seller to being a mis-seller.

Questions to ask before investing in equities

1. Will I be informed of buy and sell decisions in advance?

2. What types of stocks should I buy? Will the decisions be based on fundamental equity research by an equity research firm or on insider tips?

3. How often should I churn my portfolio? What is the suggested holding period of the stocks being bought?

4. What if I am not able to pay for my purchases within the specified time?

5. What happens if I incur a loss due to actions not authorised by me?