What is a brokerage fee?
A brokerage fee, also called a broker fee, is a commission or fee a broker charges to execute transactions on behalf of clients and or to provide numerous services to clients.
What is a broker?
A broker is an independent person or brokerage firm that facilitates financial transactions on behalf of clients.
Put differently, a broker acts as an intermediary between a buyer and a seller in order to execute a trade.
The term ‘financial broker’ is a generic term that describes a person or firm who acts as an intermediary between sellers and buyers regarding financial assets. The term includes, inter alia, a stockbroker and a forex broker.
As a verb, broker means to negotiate or arrange a deal.
Based on the type of financial asset, brokers can be classified into different categories, such as:
- A stockbroker is a qualified intermediary who buys and sells securities on a stock exchange or stock exchanges on behalf of clients.
- A forex broker provides access to the foreign exchange (forex) market, enabling clients to buy and sell currencies of countries.
- A real estate broker searches for real estates, such as offices, residential properties, and warehouses, to sell on behalf of sellers to prospective buyers.
- A credit broker is a person or firm that assists people to obtain credit for specific purposes, such as mortgages, personal loans, or loans to purchase vehicles. Credit brokers link up suitable credit lenders with people (borrowers) who need money for a specific purpose.
- A leasing broker, also known as a lease broker, refers to an individual or business that negotiates and arranges transactions, usually industrial and commercial equipment, between lessors and lessees.
- An insurance broker is a registered and qualified professional who acts as an intermediary between an insurance company and a consumer, advising the latter which insurance policy will best suit his or her needs.
- A business broker refers to a person who acts as an intermediary, assisting clients in buying or selling businesses, especially small businesses.
- A dealing desk broker also referred to as a trading desk broker or market maker is a type of forex broker who acts as a counterparty of a client, taking the other side of a client’s trades. This means the market maker takes the trade for himself/herself by entering the buy and sell orders, fixing the ask and bid prices, and then waiting for another client who may place an order.
- A non-dealing desk (NDD) broker is a type of forex broker who directs a client’s order to a liquidity provider or providers, offering the best bid/ask prices in the market.
Types of brokerage fees
The three main types of brokerage fees charged by brokers are full-service brokerage fees, discount brokerage fees, and online brokerage fees.
Full-service brokerage fees
Brokerage fees of brokers who offer full services, typically fall into two categories: a fee-based service and commissions earned from financial products and transactions.
The extensive range of services provided includes, inter alia, financial need analyses (FNAs), intermediary services, estate planning, tax advice and planning, financial planning, investment advice, and portfolio management.
A broker whose income is based on fees collects a pre-stated fee for services rendered. The fee can be received upfront (a flat retainer), or be paid after the services have been rendered, or it can be charged at an hourly rate.
Contrarily, commission-based income is generated entirely on financial products, such as insurance policies, annuities, and mutual funds, sold, or accounts that are opened.
Full-service brokers provide professional advice and customised services according to the needs and requests of each client.
Discount brokerage fees
Discount brokers do not offer the wide range of services that full-service brokers provide. They give no investment advice but initiate buy and sell orders on behalf of clients.
Services are offered at a reduced commission rate, or a flat rate which is charged for each transaction executed.
A client needs a minimal amount to open an account.
Online brokerage fees
Fees charged by online brokers are the least expensive, while services provided are limited.
Fees may vary and some brokers do not charge commissions for trades on security such as company shares. However, commissions for trades with options and futures still apply.
Online brokers are consistently lowering their fees and some even offer free trades. This is a strategy to get more clients and to increase market share.
Examples of brokerage fees
Depending on the type of broker, a client may incur some costs, such as:
- A management fee, also called an advisory fee, is calculated as a percentage of assets under the management of a broker.
- Trade commission, also referred to as a stock trading fee is a brokerage fee that is charged when a client buys or sells stocks (shares of public companies). Clients may also be required to pay brokerage fees for buying and selling other financial instruments such as options of exchange-traded funds (ETFs).
- A spread cost is charged when a client enters a position to trade a particular financial asset. Spread refers to the difference between the buying and selling price of a financial instrument.
- A forex broker charges a currency conversion fee to convert one currency into another.
- Inactivity fees may be charged by online brokers if a client has not used his or her trading account for a certain period.
Brokerage fees affect portfolio returns
Over time, brokerage fees affect portfolio returns and investment returns. Hence, brokerage fees should be carefully considered when choosing a broker.
For example, if an investor’s portfolio generated a return of 7% for a year but incurred 2% in brokerage fees, the investor’s actual return is only 5%.
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