What is a commission?
If you use an agent, such as a broker or investment adviser, to handle the buying or selling of securities on your behalf, you'll need to pay them. Often, this payment will take the form of a commission. In simpler terms, commission meaning is that of a fee calculated as a percentage of the transaction.
Where have you heard about commissions?
If you speak to any investment adviser or broker, they will probably mention the fees charged for their services. If you're just looking for someone to take a look at your portfolio or offer financial advice, it will likely be a one-off fee. If there are any transactions, expect a commission.
What you need to know about commission...
There are important differences between commissions and other fees, at least in the way these words are used to describe professional advisors in the financial services industry. A commission-based broker or adviser makes money by selling investment products, such as annuities or mutual funds, and conducting transactions with the client's money. A fee-based advisor, on the other hand, charges a flat rate for managing client's money, for example, a percentage of assets under management.
Now, that we’ve got commission definition in place, let’s dig deeper into the details. Full-service brokerages derive much of their profit from charging commissions on the client’s transactions. Commissions vary widely from brokerage to brokerage, and each has its own fee schedule for different services. Some commission costs may be higher but come with valuable advice, potentially increasing your chances of making a profit. Some costs may be lower, but come with no advice and could reduce your chances of making a profit.
Additionally, commission structures vary based on other factors, such as the number and type of trades a client makes, the size and type of the client's account and whether or not the client buys or sells securities over the phone or online.
Commissions are typically charged when an order is filled, modified, cancelled or even expired. Limit orders that go partially filled also often carry a fee, typically on a prorated basis. However, sometimes, when an investor places a market order that goes unfilled, no commission might be charged, depending on the broker.
A commission is calculated as a percentage of each transaction, and it can have a huge impact on an investor's returns. If you buy some shares, for example, you may have to pay a commission on that deal. If those shares appreciate in value, and you want to sell them, there will be a separate commission charged on that second deal.
For example, let’s say you buy 100 shares at £25 per share (£2,500). The broker charges a 2% fee, meaning your total cost is £2,550. You then want to sell these 100 shares at their new price of £40 (£4,000). Again, there is a 2% charge on the sale, meaning that you receive £3,920.
So, despite there being a £1,500 of nominal profit, your actual profit is only £1,370.
That is why it is always important to do your research and find out the commission you'll be paying for any operations beforehand, as it could easily cut into your profits. When evaluating commission structures, it is important for investors to understand and set their trading preferences.
Certain fee schedules may be more beneficial for different types of traders and investors. Consider all the costs when making any investment.
And remember, of course, that wherever you can make a profit, you could take a loss instead.