The Truth Behind Broker Commissions

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When you trade a stock, fund or option, you pay a broker a commission to place the trade for you in the open market. Brokers compete fiercely for online commission business and they will try to differentiate themselves within the industry by offering the lowest commission rates.

[VIDEO] The Truth Behind Broker Commissions

It would seem that a straightforward comparison of broker commissions would easily show what brokers are truly leading the lowest-commission war. However, that is not the case. This article will discuss the reasons why comparison is difficult and what commission rates you should be paying the most attention to.commissions

Most online broker websites have a commission comparison table somewhere within their marketing information. Invariably, the major brokers will show themselves as the low cost leader compared to their competitors.

Disclosing commissions accurately is a regulatory requirement so how can all brokers show themselves as the cost leader and still be telling the truth?

Most brokers charge different commission rates for each kind of trade. Buying 100 shares of stock costs a different amount than buying 1,000 shares or a mutual fund or a bond or an option… you get the idea.

There is an extremely large number of possible trade combinations that will all cost a different amount. Most brokers can find some combination of trades, in which, they are the low cost leader. These costs may look good but probably does not reflect the way you trade.

For example, the lowest cost for trading 100 shares of stock we found in a survey of the major online brokers was $7 per trade and the highest commission for the same trade was $15. However, if you needed to talk to a broker to execute your trade the low cost leader would charge you $27 while the higher commission broker would talk to you for free.

The commissions for mutual funds and options were also more expensive with the “low cost” leader. This additional information could easily shift the balance depending on what kind of investor you are.

The bottom line for these “comparison” tables is that they are highly footnoted, biased and don’t reflect your needs as an individual. The best course of action is to completely ignore them the same way you would toss a piece of junk-mail.

On the bright side we feel that there is a logical way to evaluate a broker’s commission schedule in a meaningful way but it requires a little effort on your part:

  1. Evaluate and record your typical trading needs and size

    Create a list of the types of trades you execute (or would like to execute), the typical size of those trades, and your trading frequency. Call the brokers you are evaluating and ask each of them to quote to you how much commissions they will charge based on your list of typical trades. They want your business so make them work for it. Evaluate broker commissions based on your own behavior rather than a piece of advertising.

  2. Ask for lower rates or other concessions

    Keep in mind that most brokers are showing you their advertised or “rack rates.” They may be willing to discount their rates for you and will frequently match the rates you want from another broker to get your business. The point is that you won’t get what you don’t ask for and this may allow you to match the commissions you want with the broker that has the tools, products and service you prefer.

  3. What are the other fees?

    Brokers publish commissions and fees in long disclosures. These are boring and are once again too general to be very useful. Now that you have a quote for the commissions that relate to you specifically you are more prepared to find out what other fees will be charged against your account.

Some of the fees you should look out for include inactivity fees, monthly or quarterly minimums, transfer fees, margin costs and the fees associated with calling a broker on the phone.

As an individual investor you can’t control the market or your returns. This makes it absolutely critical to maximize your control where you can. Trading costs are a key area to evaluate when choosing a broker and once you know what to look for it really isn’t all that difficult. A little effort on the phone can save you a lot of money.


Image courtesy Ben Fredericson.