LEVEL: BEGINNER
When investors look to buy and sell shares, they need to consider how commissions can eat into their profits–and augment their losses. This is particularly true in small-scale trades and with brokerages that charge higher commissions.
Commissions are one of the reasons why big investors can make money more easily than smaller investors. Most assets will fluctuate in price by 0.1% or 0.2% during a trading day. Big investors can profit from these fluctuations with a strategy called high-frequency trading, but smaller investors cannot replicate these gains as easily because commissions eat into the gains.
All investors need to calculate the impact that commissions have on their profits before buying or selling an asset. This involves knowing how different brokerages charge for trades as well as what commissions are charged for different types of trades. On the Zolio platform, the commission charge will be 0.45 cents per share.
Types of Commissions
Different brokers will charge different commissions, and these will make up a varying portion of the brokerage’s total revenue. Full-service brokerages earn most of their profits from commissions, and their fees are usually the highest of all types of brokers. This is because they offer advice on which assets their clients should buy and sell, and they charge a fee for that expertise.
Fees can run approximately $150 per trade with a full-service broker, so investors will need to earn at least that much just to break even. This means an investment of $10,000 would have to gain 1.5% in value just to pay for the commissions. Full-service brokerages also charge maintenance fees, which can cost over $10 per month just to keep an account active.
These high fees mean that many investors have turned to discount brokerages, which offer trades for $7.50-$10.00 or less per transaction. Discount brokers also charge no maintenance fee, and have lower minimums than full-service brokerages. In exchange for the lower price, investors choose their own stocks–discount brokers offer little guidance, and make no investment recommendations to clients. This means customers of discount brokers are in charge of making their own investment decisions. Still, investors are attracted to this low-cost option, since a $10,000 investment only needs to appreciate by 0.15% to make up for the cost of a $15 commission, assuming it costs $7.50 to buy and sell the asset.
Avoiding Commissions
Investors can avoid commissions thanks to some partnerships between ETF issuers and select brokerages. This means investors can buy and sell “commission-free” ETFs with a particular brokerage. This freebie usually has some strings attached, such as a minimum holding time or a minimum trade amount. (Participants on Zolio are charged the same uniform 0.45 for an ETF transaction as for a stock transaction.) Full-service brokers will also offer commission-free investing to some clients, provided they pay a maintenance fee typically around 1-2% of the account’s value. That’s hardly a discount, though. For an investor with $300,000 in an account, that fee will run to at least $3000 per year, or $250 per month.
In the end, commissions of some sort are an inevitability for most investors, so it is important to calculate the expected return on an investment after losses from commissions.