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How Do Broker Fees and Payment Plans Work?

Unless he or she charges an asset-management fee meaning he or she takes a slice of the assets managed each year or a flat fee for account management (as in the cash-management accounts common to many brokerage firms), you should expect any broker you meet to be paid on commission.

Its 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 brokers 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. If you want to buy the grandchildren five shares of Microsoft, your commission could be as expensive as one or two of those shares; by comparison, if you buy a round lot (100 shares), you might be laying out roughly the same dollars to get the trade completed.

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 funds 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. Dont. 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 moneys worth; if you and the broker/manager employ a buy-and-hold strategy, run the numbers to make sure that you arent better off with straight commission.

Adapted from Getting Started in Finding a Financial Advisor.

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