Financial Literacy

Charles Merrill: From Customers Coming First to Brokerages Going Wrong

Charles Merrill: From Customers Coming First to Brokerages Going Wrong
By Dr. Steve Sjuggerud, Chairman, Investment U
Thursday, May 1, 2003: Issue # 235

“Now is the time to get out of debt. We do not urge that you sell securities indiscriminately, but we do advise that you take advantage of present high [stock] prices and put your own financial house in order” – Charles Merrill, head of Merrill Lynch, in a letter to his customers before the 1929 crash

“The interests of our customers MUST come first.” -Charles Merrill’s mantra to his brokers in the 1940s

Where are the Charles Merrills today when you need them?

Can you believe that Charles Merrill strongly urged all of his customers to sell in the year before the Great Crash? What’s more, in the months before the crash in 1929, Merrill pleaded to President Coolidge to speak out against speculation in stocks, and at the same time Merrill liquidated his firm’s stock portfolio. Merrill then transferred all his brokerage clients and employees to E.A. Pierce and went into semi-retirement. Talk about timing…

Imagine that happening today… the head of a Wall Street firm telling his clients to get out of stocks and use the proceeds to pay off their debts. It would be business suicide…

Or would it? Let’s take a quick look at how Merrill put the customers first, giving them the chance to succeed in investing. Then we’ll look what’s wrong with the big Wall Street firms today, the potentially serious consequences to your portfolio, and what you can do to protect yourself.

How Charles Merrill Brought Wall Street To Main Street

Charlie Merrill became famous for bold acts. He came out of semi-retirement, and was running Merrill Lynch again by 1940 (after the death of Mr. Lynch), and he went on to change the investing world forever… More than anyone else, Charlie Merrill is personally responsible for the “democratization” of Wall Street. His catch phrase was “Bringing Wall Street to Main Street,” and that’s just what he did.

Until Merrill Lynch came along, brokers had a bad reputation as hustlers. For example, there was no law of a maximum commission back then, so brokers extracted as much as they could. Merrill Lynch not only charged the minimum commission the law would allow, he campaigned to lower the minimums. Other brokerage firms charged for research, but Merrill was the first to do away with that practice. Other firms had account maintenance fees, fees for monthly statements, fees for collecting income on bonds, etc. Merrill waived all such charges.

The customers knew the Merrill brokers were different. They were paid salaries, not commissions, and the customers were well aware of this. The Merrill brokers had to go through a real training program, the first of its kind on Wall Street, where future brokers (”account executives,” a new term of Merrill’s) were indoctrinated with Charles Merrill’s slogan “The interests of our customers MUST come first.” At Merrill’s death in 1956, Merrill Lynch had 115 offices nationwide and was the largest broker in America, and the first to target middle America.

Here’s What’s Wrong With The Big Firms Today

Times have changed – even at Merrill. I doubt we’ll ever see the CEO of a Wall Street firm tell his customers to sell their stocks to pay off their debts like Charlie Merrill did. Plus, I doubt you’ll ever see the CEO of Merrill talk about charging customers the lowest commissions allowable by law and campaigning to lower commissions even more.

I don’t know the status of random “account maintenance” charges, but they seem to be coming back… I was surprised when my wife told me that we were hit with an “account maintenance” charge by Schwab (probably because of inactivity) in an Educational IRA for my 2-year-old son (I don’t know the specifics of the charge). These are just bogus charges put in place in an effort to raise profits.

While these things are irritating realities, they are NOTHING compared to what you REALLY have to worry about…

There is a serious breakdown in the mutual fund/brokerage business today. The chain of accountability leads nowhere… And the end result of that for most individual investors will be financial ruin.

Van Tharp (of the International Institute of Trading Mastery) and I were talking about this over dinner last week at the Options Conference in Baltimore…

Here’s the Way Mutual Funds Works:

Mutual funds take your money, combine it with other people’s money, and invest it on your behalf. So far, so good. But instead of investing it to make you a profit, the fund manager has a different objective – to keep his high-paying job…(I know this sounds cynical…but bear with me here).

Now you’d think that his/her job would be to make you a profit. But his job description is not to make you a profit; it’s to beat a stock market index. So if his benchmark index (say the Nasdaq) is down 75%, and he’s “only” lost 70% of your money, that fund manager gets a huge bonus for outperforming his benchmark. Meanwhile, your nest egg is shot.

And how does he keep his high paying job? By not screwing up too badly. That’s it. And how does he keep from screwing up too badly? By holding a portfolio that is almost identical to his benchmark index – so he’ll never do particularly well or particularly poorly. I know this is what goes on. I was in the fund business, as the Vice President of a global mutual fund for a year.

What The Downward Spiral Of Mutual Funds Will Look Like

Now consider this… Microsoft is the major stock in all three major indexes – the Dow, the S&P 500 and the Nasdaq. So typical fund managers hold a heck of a lot of Microsoft – which is a ridiculously expensive stock (trading at 9 times sales). When individual investors get tired of poor performance, they will start to sell their mutual funds. This selling will drive down shares like Microsoft, as funds (having to meet shareholder liquidations) sell the easiest to trade stocks, like Microsoft.

A fall in shares like Microsoft could then lead to a vicious downward spiral in the indexes, as the major stocks have the power to drag entire indexes down. Smaller stocks may not be hurt as badly, as they’re not as widely held by the funds. Or at least this is a potential scenario that Van Tharp lays out.

A major investment firm recently paid Dr. Tharp a ton of money to speak to its fund managers throughout Asia about controlling risk and preventing losses in their portfolios. Van told me that they weren’t interested in what he had to say. “it did not apply to them,” explained Van. They “weren’t allowed to cut their losses.” They had to stay fully invested at all times. And they had to own the big stocks that made up their benchmark indexes. In essence, if the market were crashing, these fund managers would have to sit back and watch you lose money.

How did we reach this point?

That is, the point where the people that are supposed to be in charge of making you money sit aside and watch you lose it?

I don’t know. There are some folks, like Vanguard founder John Bogle, that are carrying on Charlie Merrill’s fight. But his voice isn’t loud enough yet. Chances are, the individual investor won’t hear it. Instead, the individual investor will listen to the financial planning help of his financial planner, who was instructed by the folks in the big buildings in New York to buy mutual funds that are run by fund managers who are not allowed to try to protect the money they manage. Yikes.

What can you do? I think if you’re reading this, you’re already doing what you need to do… you’re educating yourself… arming yourself so you don’t end up like everyone else. You can’t save everyone. But you can save yourself. Keep learning.

In addition, one thing I’d highly recommend is a seminar that Dr. Van K. Tharp and I have put together. It’s called Stock Market Mastery 101. We have done this seminar many times over the last few years, to outstanding reviews. In short, it’s everything you need to know to succeed in stocks, and nothing you don’t.

Good investing,


Today’s Investment U Crib Sheet

  • IU Glossary: Above I talk about “benchmark indexes.” An index (a composite figure like the Dow Jones Industrial Average) becomes a benchmark index when you choose it as the standard against which to measure your own portfolio’s performance over time.
  • One way of learning is to listen to people with experience. The more experience, the better. Richard Russell writes an intense daily column on the stock market. He has written this letter continuously since 1958. That’s experience worth following.

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