Interrogate your broker! 14 questions you should ask before opening an account at a brokerage firm

Imagine two retired people, who would like to guarantee some growth and income to supplement their Social Security. They open an account at a well-known brokerage firm, and entrust it to their broker, as they do not consider themselves experienced investors. Their broker, perhaps a member of the Idea of the Week Club, seems to be nice, but is using fund selection instead of diversification to manage risk.What happens next? The couple gets really disappointed.

She and her husband suffer the consequences of bad advice, performance chasing, high fund expenses and reversion to the mean. To make matters worse, their account is charged an annual 1.35% "wrap fee" which makes all trades commission free. If you pay 1.35% a year for free trades, don't be surprised if your broker, attempting to justify this fee, recommends more trades than might be prudent. Unfortunately, more trading is usually accompanied by lower returns.

This experience can serve as a lesson to others. Here are some important questions that these two pensioners should have asked before engaging the services of a broker. As Ronal Raegan would say, "Trust and verify".

2. Do you, or your firm, have the ability to identify stocks and mutual funds that will do well in the future? ("No" is the only acceptable answer.)

3. If your recommended funds outperform this year, how can I know that it wasn't just blind luck? On the other hand, if they underperform, how can I know that I can trust your recommendations? (This is a trick question. One year performance proves nothing.)

4. Do you believe that the stock funds in my portfolio will outperform a total stock market index fund? (Any answer other than "probably not" should be a disqualifier.)

5. Do you recommend individual stocks to clients? (Hopefully not, individual stocks increase portfolio risk and provide no assurance of higher than asset class rates of return.)

6. Must I outperform the market to meet my financial goals? (Why risk what you have to get what you don't need?)

7. Will my account be charged a wrap fee? If so, why?

8. Will my portfolio be adequately diversified and will my asset allocation be appropriate for my goals, time horizon and risk tolerance?

9. Is your investment strategy based on academic research or predictions about the future?

10. Are you recommending the same mutual funds today that you recommended two years ago?

11. What is your strategy for generating the income that I will need in retirement?

12. Will trades in my brokerage account be made only after considering the tax ramifications?

13. Will I find any surprises when I look you up on BrokerCheck ? (A BrokerCheck Report contains information about a broker's licenses, credentials, employment history, customer disputes and disciplinary actions.)

14. Will our relationship be based on a fiduciary standard of care or a suitability standard of care?

This last question is very important. A fiduciary must make recommendations that are in the client's best interest and disclose all important facts about compensation and any conflict of interest between the recommendations and a client's interests.

The brokerage industry insists upon being held only to a suitability standard. Brokers aren't required to act in your best interest, fully disclose fees or conflicts of interest and only need to recommend "suitable" products — a much lower standard of care.

Under a suitability standard, it can be difficult for clients to know if their broker's enthusiasm for an investment is because of the benefit they might receive from owning it or because of the commission it pays. If your broker asserts that he or she is acting in a fiduciary capacity, ask for a written confirmation.

My friends engaged the services of a broker whose short-term investment strategy focused on predictions, past performance and brokerage products. They would have been better served by someone with a long-term investment strategy that focused on academic studies, the lessons of history and their individual needs. The distinction between these two investment models couldn't be clearer.

Don't be afraid to ask these questions. Anyone who gives financial advice and is worthy of your trust will be happy to answer them.