(MONEY Magazine) – Merrill Lynch calls them financial consultants. Paine Webber prefers investment executives. But whatever you call them, they're stockbrokers. And if you're like most of the 15 million Americans who use full-service brokers, you may think the guidance you're getting is worth the commissions that you have to pay -- even when they're three or four times what a discount broker would charge. Well, think again. These days, most full-service brokers bear little resemblance to the John Houseman stereotype that firms still advertise. No longer do brokers make most of their money from selling stocks and bonds to small investors. Today's broker typically gets only about 45% of his or her income that way; the rest comes from selling mutual funds, annuities, limited partnerships and other financial products that carry commissions much higher than those on individual stocks and bonds. Likewise, your broker's employer usually earns less than a fifth of its revenues from commissions paid by investors like you, vs. more than half only 20 years ago. The brokerage industry's focus has shifted to businesses like asset management and investment banking -- operations that produced record- breaking earnings for the firms last year but may cut into your profits or at least create a conflict of interest for your broker. ''There's a fundamental flaw in the whole full-service brokerage system,'' says John Markese, president of the American Association of Individual Investors in Chicago. ''What's good for the broker is often bad for the customer.'' To make you a savvier investor -- and enable you to save money on commissions -- this story explains how brokers and their firms make their money and how that can adversely affect the advice they give you. Here are a few examples: -- Brokerages are major mutual fund managers. They sponsor more than 630 stock, bond and money-market funds with assets totaling $307 billion, up from 232 funds with $140 billion in 1985. Many firms pay their salespeople extra to sell these house specials. Often they have to: In a recent study, mutual funds owned by brokerage firms underperformed competitors by an average of 20%. -- Brokerages are their own most important customers. Each year firms trade an estimated $600 billion of stocks and bonds for their own accounts. When they make a mistake and end up holding securities they want to get rid of, they sometimes unload them on small investors. -- Brokerages are investment banks. They earn big fees for creating new financial products and bigger ones for selling them to customers, even though existing investments may be equally rewarding and less expensive for you. The shift away from traditional brokerage services dates back to 1975, when the government abolished fixed commissions. That allowed discount brokers such as Charles Schwab and Quick & Reilly to slash their charges by as much as 75%. Today, for example, some discounters charge $56 on a $10,000 trade, vs. $218 at full-service firms. As a result, discounters now control about 25% of the small-investor market. Then, in the 1980s, droves of individual investors abandoned stocks for mutual funds. Since 1980, individuals have been net sellers of $872 billion of stocks and net buyers of $574 billion of funds. To survive, full-service brokerages scrambled for new ways to make money. Some moved into such businesses as corporate finance and investment banking or created their own mutual funds. And almost every brokerage has raised the commissions and fees it charges investors like you. These changes have rewarded Wall Street, which rang up a record $5.8 billion in pretax profits last year. But they've penalized small investors. ''One reason brokerage firms have been successful is that they have figured out more and better ways to get their customers' money,'' says Craig Hoogstra, director of financial services for the American Association of Retired Persons in Washington, D.C.

COMMISSIONS Retail commissions -- what a brokerage charges you for buying or selling stocks, bonds, mutual funds and limited partnerships -- account for 15% of industry revenues today, about a quarter of the proportion of 20 years ago. Typically, commissions are charged on top of the price of the investment you're trading. For example, if you buy 100 shares of XYZ Co. at $100 a share with a commission of 2.5%, you'll pay $10,250 -- that's $10,000 for the stock plus $250 in sales charges. (Your broker generally keeps 35% to 45% of the commission, while the firm pockets the rest.) With many types of bonds and some other investments, the commission is built into the price and is known as the spread. If you buy $10,000 of Sunny City bonds, you write your check for that amount; if you sold the same bonds, you'd get $9,800. The $200 difference is the spread. Generally, the more complicated the investment -- that is, the more work the broker has to do to sell it -- the higher the commission. So you'll pay less than 1% to buy a U.S. Treasury bond, one of the simplest and safest investments, but 8% or more on limited partnerships, which invest in such risky ventures as real estate or oil wells. The result: ''There's a built-in incentive for brokers to sell more complicated and riskier products,'' explains Barry H. Alper, a former E.F. Hutton broker who currently runs Investors Arbitration Services, a Woodland Hills, Calif. consulting firm that helps investors recover losses caused by broker fraud or negligence. Since ^ 1975, for example, investors have poured $140 billion into more than 15,000 limited partnerships; at least 25% of those investments have lost money since they were sold. MONEY tip: If you do not want to take your business to a discount house, always ask full-service brokers for a break on commissions; they often can give you as much as 50% off, even if you trade only six times a year. Moreover, stay clear of any investment where the commission seems out of line: higher than 2% on actively traded stocks, or 5% on thinly traded over-the- counter issues. For bonds, spreads should never be above 5%, and limited partnerships should carry initial sales charges of no more than 8.5%. On mutual funds, the typical sales charge is around 5.75% for stock funds and 4.75% for bond funds.

TRADING FOR A FIRM'S OWN ACCOUNT More than $17 billion, or nearly a third of industry revenues, was generated last year by what Wall Street calls principal transactions. That's when a brokerage buys and sells securities for its own account. As a result, brokerages -- like all investors -- sometimes end up owning stocks or bonds that they don't want. But the firm has an out that you don't: It can encourage its brokers to unload those securities on customers. ''The client doesn't know that the broker is just trying to get rid of the stock or bonds,'' says Alan Hobart, a former broker at a major firm. In a typical case this past January, Prudential bought 50,000 shares of a stock offering at $15 a share, or 50 cents below the official price of $15.50. To encourage its brokers to move the stock, Prudential in effect offered them an extra 50 cents for every share they sold -- or an additional $200 on a $6,200 trade. ''The client doesn't pay any more than normal, but you have to wonder whether the extra money influences the broker,'' says Hobart. Prudential declined comment. MONEY tip: When your broker recommends a stock, ask whether the firm has issued a public buy recommendation. If not, your broker could be trying to dump a loser on you. Also, inquire whether the broker is being paid extra to sell it. If the answer is yes, stay clear. If he or she won't answer, you may want to stay clear of the broker too.

SELLING NEW ISSUES OF SECURITIES Stock and bond underwriting -- buying a new issue of securities from a corporation or government agency and reselling it to the public -- exploded in 1991, to a record $583 billion, nearly double the 1990 level of $314 billion. In all, underwriting accounted for 9% of brokerage revenues, or 30% more than in 1979. But in the rush to underwrite new issues, firms can steer customers into harm's way.

Consider, for example, initial public offerings (IPOs), the sale of shares in private corporations to the general public. Last year, Wall Street raised $16.5 billion for 366 companies that were new to the stock market, compared with $4.5 billion raised for 172 IPOs in 1990. In the first three months of this year alone, 163 companies raised nearly $8.5 billion through initial offerings. Brokerages keep about 7.3% of the money raised in an IPO, compared with about 5% for stock offerings from companies with shares already trading and less than 1% for bond offerings. MONEY tip: It's possible that you can win big with IPOs. Home Depot's stock price has zoomed an astonishing 20,483% since being issued in 1981. But it's unlikely. In a recent study at the University of Illinois at Urbana/Champaign, IPOs underperformed a group of similar but seasoned stocks by a stomach- churning 44%. So always be very skeptical if your broker touts an IPO -- and ask whether there's a comparable stock that you can buy instead.

ASSET MANAGEMENT There's a good reason why stockbrokers try to push customers into house mutual funds or money-management accounts: They generate steady profits. Firms collect fees of 0.3% to 0.75% of fund assets a year, or as much as $7.5 million on every $1 billion in a portfolio. With a total of $600 billion under management last year, those fees hit $2.5 billion, or about 4% of total industry revenue, up from about 1% a decade ago. The major conflict here is that brokers are tempted to urge customers to buy house funds irrespective of whether they are the best investments. Often they aren't. In a recent ranking of the 31 largest mutual fund groups by the Institute for Econometric Research in Fort Lauderdale, all four of the worst performers were brokerages -- Dean Witter, Merrill, Prudential and Shearson. Says Walter L. McGowan, a stockbroker who left Merrill Lynch in 1990 for Gruntal & Co., a brokerage based in New York City that doesn't have its own mutual funds: ''Brokers at Merrill Lynch were under constant pressure to put money into house funds regardless of how good they were.'' A Merrill spokesman denies that, pointing out that the firm sells several hundred funds, of which only 60 are in-house. Still, Merrill, the dean of Wall Street money managers, took in $744 million, or 6% of revenues, from asset management in 1991, vs. $298 million, or 4%, in 1985. More than half the brokerage houses pay their brokers a bonus to lure clients' money into house management accounts. For example, a Paine Webber broker who recommends a $10,000 investment in a 6.25% load fund sponsored by the firm could earn $294, vs. $231 for pushing a similar fund managed by an outside company. MONEY tip: Ask whether your broker collects more to sell a house-brand product. Again, if the answer is yes or the question is evaded, consider asking for a fund from another sponsor. Brokers can usually provide comparable products from independent fund groups, often at lower costs.

ADMINISTRATIVE FEES Though they account for about 1% of the brokerages' total revenues, administrative fees are hot moneymakers. The basic tactic: imposing new charges or raising old ones for routine services. Here too, Merrill sets the pace. Last year, the firm doubled (to $4.85) its charges for postage and handling on a transaction. Other firms, such as Paine Webber and Smith Barney, followed with smaller hikes. Seems like small change, but it's jingling louder every day. Figuring four trades a year for each of Merrill's 6.5 million customer accounts, the brokerage collects more than $127 million in handling fees, about 1% of total revenues. MONEY tip: Be on guard for nickel-and-dime charges: If you don't make a trade at least once a year, many firms will charge an inactive-account fee, usually $50 a year. Prudential duns you $50 for transferring an account to another firm. And on almost all accounts holding stocks or bonds, Merrill charges a minimum annual fee of $35 per household.

LENDING TO CUSTOMERS Brokerage firms often let customers leverage their money by buying securities on margin. Typically, the customer puts up half the purchase price in cash and borrows the rest from the brokerage. Firms have two powerful incentives for encouraging margin buying. For one, it's profitable. Today, brokerages generally charge customers as much as 9% for margin loans, 1 1/2 to 2 3/4 percentage points more than the firm pays to borrow the money from banks. Second, margin lending enables clients to buy twice as many securities. ''That means double commissions for the firm,'' says Bruce Sankin, a former Prudential broker in Fort Lauderdale and author of What Your Stockbroker Doesn't Want You to Know! (Business Publishing, $22). But it also means twice the risk for margin investors: If you crap out on a margin account, not only have you lost your money, you've lost somebody else's as well -- and you still have to pay interest on it.

MONEY tip: Most investors should avoid buying on margin, period. But if you insist on doing it, negotiate for a lower interest rate. Just as with commissions, good customers can get more than 20% knocked off the going margin rate. Finally, before deciding to pay for a full-service broker, make sure that the service you're getting is worth the price. And think about this: Thomas Saler, a former stockbroker and author of Lies Your Broker Tells You (Walker, $19.95), has calculated the performance of two people who began with $20,000 two decades ago -- one using a full-service broker and the other investing in a stock index fund. Even if the broker-led investor matched the market's 12% average annual return during that period (no mean feat for even the best broker), Saler figures the investor who used the index fund would have roughly $80,000 more in the bank today. For that kind of money, you should be getting nothing less than brilliant investment recommendations from your full-service broker, plus service fit for royalty.

CHART: NOT AVAILABLE CREDIT: Source: Securities Industry Association CHARTS BY MIMI MAXWELL CAPTION: WHERE BROKERAGES MAKE THEIR MONEY Commissions paid by individual investors account for only 15% of the typical brokerage firm's business. This breakdown of total industry revenues shows where the brokerages make their money -- and where they may give top priority to someone other than you.

CHART: NOT AVAILABLE CREDIT: CHARTS BY MIMI MAXWELL CAPTION: HOW MUCH A BROKER CAN EARN ON A $10,000 INVESTMENT Depending on the type of investment you buy, com missions can range from less than 1% to more than 9%. Brokers typically keep about a third of that. Here's how much an average broker would make on nine differ ent $10,000 transactions. In general, the more compli cated the investment, the more a broker gets to keep for selling it.