What is a commission?
A commission is a service commission assessed by a broker or investment counselor to provide investment advice or to manage the buying and selling of securities for a client.
There are important differences between commissions and fees, at least in the way these words are used to describe professional advisers in the financial services industry. A paid commission advisor or broker earns money by selling investment products such as mutual funds and annuities and by trading in client money. A paying advisor charges a flat rate to manage a client’s money. It can be a dollar amount or a percentage of assets under management (AUM). Sales between family members are often donations of stocks, which are not based on commissions.
[Important: A fee-based advisor charges a flat rate for managing a client’s money, while a commission-based advisor makes money by selling investment products and conducting transactions.]
Understanding the Commission
Full-service brokerages derive much of their profit from billing commissions on customer transactions. Commissions vary widely from one brokerage to another and each has their own fee structure for various services.
Commissions may be charged if an order is filled, canceled or changed, and even if it expires. In most situations, when an investor places an unexecuted market order, no commission is charged. However, if the order is canceled or changed, the investor may find additional fees added to the commission. Limit orders which are often partially executed will incur fees, sometimes pro rata.
Commissions can eat away at an investor’s returns. Suppose Susan buys 100 shares of Conglomo Corp. for $ 10 each. Her broker charges a 2.5% commission on the transaction, so Susan pays $ 1,000 for the stocks, plus $ 25. Six months later, his shares appreciated 10% and Susan sold them. His broker charges a 2% commission on the sale, or $ 22. Susan’s investment brought her $ 100 in profit, but she paid $ 47 in commissions on the two transactions. His net gain is only $ 53.
For this reason, online discount brokerages and robot advisers are gaining popularity in the 21st century. These services provide access to stocks, index funds, exchange traded funds (ETFs) and much more on a user-friendly platform for independent investors. Most charge a flat fee for transactions, usually $ 4.95. These services provide a wealth of news and financial information, but little or no personalized advice. This can be inconvenient for novice investors.
Commissions vs fees
Financial advisers often present themselves as fees rather than commissions. A paid advisor charges a flat rate to manage a client’s money, regardless of the type of investment products that the client ends up buying. This flat rate will either be a dollar amount or a percentage of assets under management (AUM).
A commission-based consultant earns income from the sale of investment products, such as mutual funds and annuities, and from trading in client money. So the advisor gets more money by selling products that offer higher commissions, such as annuities or universal life insurance, and by moving the client’s money more frequently.
A professional advisor has fiduciary responsibility to offer the investments that best serve the client’s interests. That said, a commission-based advisor may try to direct clients to investment products that pay generous commissions.
Key points to remember
- Full-service brokerages derive much of their profit from billing commissions on customer transactions.
- Commissioned advisers earn money by buying and selling products on behalf of their clients.
- When considering a brokerage or advisor, check out the full list of service commissions.