What is a Brokerage Fee?
A brokerage fee compensates a broker for executing a transaction. It is usually, but not always, a percentage of the transaction value. In finance, stockbrokers most often come to mind, but real estate agents and business brokers frequently charge brokerage fees.
How Does a Brokerage Fee Work?
Let's assume you would like to purchase 100 shares of Company XYZ at $35 per share. If your broker charges a 2% brokerage fee to make the trade, the cost of your transaction would be:
$35 x 100 shares = $3,500
$3,500 x .02 = $70
If, several days, weeks or years later, you want to sell the shares, you will probably pay another brokerage fee, again based on the value of the shares. Let's say the value of the Company XYZ shares was $50 when you sold. The net amount you would receive from the sale would be:
$50 x 100 = $5,000
$5,000 x .02 = $100
Although most investors would calculate the profit on the Company XYZ investment as simply the difference between $5,000 and $3,500 ($1,500 -- or 42.85%), the savvy investor takes brokerage fees into account and knows that the real profit is $4,900 - $3,570 = $1,330 (or 37.25%).
Why Does a Brokerage Fee Matter?
As we demonstrated in the example above, brokerage fees eat into returns and should be considered when making any investment. The Company XYZ investment returned 37.25% after brokerage fees rather than 42.85% -- a full 5.6% of the return went to brokerage fees. In addition, commissions are not the only fees associated with brokerage accounts -- many brokerage firms charge 'annual maintenance fees,' for example, that also reduce the investor's account value.
The brokerage fee you pay is often dictated by the type of broker you use. Full-service brokers provide a lot of services -- research reports, advice and even tax help. Their clients usually pay high fees in return for these services. Discount brokers, on the other hand, usually focus on executing trades and do little else. Their clients often pay much lower fees. In either case, fee structures also vary based on things like the size of the client's account, the number or size of trades a client makes, the type of trades a client makes, and the kind of account the client has. For example, sometimes a broker will charge a flat rate for trades below a certain level or charge less for online trades.
It is important for investors to understand their trading preferences when evaluating fee structures. For example, an asset-based account, which charges an annual fee in return for zero or greatly reduced brokerage fees, is often more costly for buy-and-hold investors who don't trade often -- in their case, paying a brokerage fee once or twice a year may be far cheaper than giving away a percentage of the account every year.