How Do Broker Fees and Payment Plans Work?
It's not always easy to figure out just how much commission, or how the broker gets paid at all for some services, which is why you will need to ask. Moreover, the broker's pay scale may change depending on the size of your investments; the more money you are putting into play, the more you may feel like you get the volume discount.
With stocks, for example, smaller trades and low trading volume generally result in higher commissions per share.
On mutual funds, investors pay a "load" that can either be taken off the top as a front-end charge (typically 3.0 to 5.5 percent) or paid in the form of higher expenses over several years of owning the fund, plus a back-end charge if the fund is sold during the first few years of ownership. Some funds drop the sales charge -- meaning no money comes off the top to pay the broker -- but charge higher expenses for the life of the investment, with the broker capturing the "trail commission" the whole way.
On bonds, there usually is no explicit commission amount. The broker buys the bond at one price and sells to you at another; the "spread" -- the difference between the two prices -- represents the commission. As in stocks, the more bonds bought, the smaller the spread.
Then there are other products, ranging from limited partnerships to annuities, life insurance, new stock and bond issues, and more. Commissions can get as high as 10 percent in these cases.
The general rule on these types of financial products is that the more complicated and harder to sell, the bigger commission the broker will get for convincing you to buy it.
Brokers may also be compensated on an ongoing basis. The "12b-1 fees" charged for sales and marketing on some mutual funds apply to accounts every year. Essentially, the fund takes as much as 1 percent of your account balance each year and pays a portion to the broker; the charge is in addition to the ongoing management fees charged by the fund, but it is calculated into the fund's "total expense ratio." Annuity companies and partnerships often charge similar ongoing fees.
Because these ongoing fees are removed painlessly -- without a bill or confirmation statement that lays out the exact cost -- they are easy to forget about. Don't. If you should decide to change brokers, make sure that any and all ongoing fees are transferred to the new broker; if you do not specify the change, the broker (or firm, if your broker changed firms or left the business) will continue to receive these ongoing payments in perpetuity, without providing you with one shred of the ongoing service you are actually paying for.
Last, if your broker is functioning as a money manager -- essentially developing and executing an investment strategy on your behalf -- she may charge something called a "wrap fee," which combines management and brokerage fees. These fees can run as high as 3 percent of the assets under management, which is pretty steep. Something closer to 1.5 percent or 2 percent is about average for a stock wrap account; 1.0 to 1.5 percent is the norm with mutual fund wraps. A wrap fee lets you know in advance what you will pay a broker/money manager, but make sure you are actually getting your money's worth; if you and the broker/manager employ a buy-and-hold strategy, run the numbers to make sure that you aren't better off with straight commission.
By Chuck Jaffe