What is a commission?
A commission is a payment charged by a broker or salesperson for executing an investment transaction or for selling an investment product to a client. In practice, a commission is a cost you incur when someone else executes trades or sells you a financial product.
Key definitions
– Commission: a charge assessed for executing a trade or selling an investment product (often fixed per trade, per share, or as a percentage).
– Fee-based advisor: an advisor who charges clients a set fee (either a flat dollar amount or a percentage of assets under management, “AUM”) for their services.
– Commission-based advisor: an advisor or broker who earns compensation by receiving commissions tied to sales or transactions (so their pay increases when they sell products or trade more frequently).
– Assets under management (AUM): the total market value of assets an investment professional manages on behalf of clients; AUM is commonly used to calculate advisor fees (for example, 0.25%–0.50% per year).
How commissions work (plain language)
– Brokers may charge commissions when you buy or sell a security. That charge can be:
– a flat dollar amount per trade (e.g., $4.95 per trade),
– a per-share charge (e.g., $0.005 per share),
– or a percentage of the trade value (e.g., 0.5%).
– Some brokers also apply charges when an order is changed, canceled, partially filled, or expires — check the broker’s fee schedule for rules about partial fills or canceled orders.
– Many modern online brokers now offer commission-free trading for many stocks and ETFs; other costs (spreads, fund expense ratios, platform fees, or AUM fees for managed accounts) can still apply.
– A fee-based advisor is paid directly by the client, regardless of which products are bought; a commission-based advisor receives money when they sell certain products. That difference can create a potential conflict of interest because higher-commission products might be more profitable for the advisor.
Why commissions matter to returns
Commissions reduce your net return. Always subtract total trading costs from gross gains when assessing performance. Small commissions can compound into a large drag if you trade frequently.
Worked numeric example
Assumptions:
– Purchase: 150 shares at $20.00 each → trade value = $3,000.
– Buy commission: 1.5% of trade value.
– Six months later: price up 8% → new price = $21.60.
– Sell commission: 1.0% of proceeds.
Step-by-step:
1. Buy commission = 1.5% × $3,000 = $45.
2. Cost basis including commission = $3,000 + $45 = $3,045.
3. Sale proceeds before commission = 150 × $21.60 = $3,240.
4. Sell commission = 1.0% × $3,240 = $32.40.
5. Net proceeds after sale commission = $3,240 − $32.40 = $3,207.60.
6. Net profit = $3,207.60 − $3,045 = $162.60.
Interpretation: The position gained $240 on price movement, but commissions of $77.40 reduced the investor’s net gain to $162.60.
Checklist — what to verify before you trade or hire an advisor
– Fee schedule: exact commissions, per-share vs. per-trade, minimums, and any ticket or platform fees.
– Order handling: how commissions apply to cancelations, modifications, partial fills, and expired orders.
– Account-level charges: inactivity fees, account maintenance, wire fees, or
or transfer fees. – Exchange and regulatory fees: who bears exchange fees, SEC fees, or clearing charges? – Margin and financing: interest rates, how interest is calculated, and whether commissions impact margin requirements. – Routing and execution quality: whether the broker uses payment for order flow (PFOF) or routes to particular venues; ask for execution-quality reports.
Common commission structures — quick reference
– Per-trade (flat) fee: a fixed cost per order, e.g., $4.95 per trade. Formula: commission = flat_fee.
Example: flat $5 on a 100-share trade costs $5, or $0.05 per share at 100 shares.
– Per-share fee: charged on each share traded, e.g., $0.005/share. Formula: commission = per_share_fee × shares.
Example: $0.005 × 1,000 shares = $5.
– Percentage of trade value: common for foreign stocks or some brokers, e.g., 0.5% of trade value. Formula: commission = pct × (price × shares).
Example: 0.5% × ($20 × 100) = $10.
– Tiered or hybrid: a combination (e.g., $0.0035/share + $0.49 per trade). Compute both components and sum.
– Zero-commission offers: may exist for certain US equities/options but check for hidden costs (spreads, PFOF, limited order types).
Worked comparison: when is per-share cheaper than flat?
Let flat_fee = F, per_share_fee = p. Break-even shares N satisfy: F = p × N => N = F / p.
Example: F = $5; p = $0.005 → N = 5 / 0.005 = 1,000 shares. If you trade fewer than 1,000 shares, per-share pricing is cheaper; above 1,000 shares, the flat fee wins.
Round-trip breakeven price move
Definitions:
– Round-trip commissions = buy_comm + sell_comm.
– Break-even per-share price move = round-trip_commissions / shares.
Example: buy commission = $5, sell commission = $5, shares = 100.
Round-trip_commissions = $10.
Break-even = $10 / 100 = $0.10 per share.
Interpretation: price must move at least $0.10 in your favor (ignoring taxes and slippage) for the trade to cover commissions.
Hidden and indirect costs to watch
– Bid-ask spread: difference between the highest buy price (bid) and lowest sell price (ask). Wider spreads increase implicit cost.
– Slippage: execution price worse than expected, often when using market orders or in thinly traded securities.
– Payment for order flow (PFOF): brokers may receive payments for routing orders to market makers; it can affect execution quality.
– Exchange/regulatory pass-throughs: fees charged by exchanges or regulators that may be added to your bill.
– Platform fees and data charges: market data subscriptions, API access, or platform “pro” features.
– Margin interest: financing cost for borrowed funds; expressed as annual percentage rate (APR) and applied daily on the borrowed balance.
Steps to evaluate broker costs — checklist
1. Gather the fee schedule: per-trade, per-share, minimums, ticket/platform fees, margin rates, and data charges.
2. Simulate your typical trade: use your average trade size and frequency to compute annualized commissions.
3. Include indirect costs: estimate average spread and slippage per trade and add to explicit fees.
4. Ask for execution statistics: average execution price vs. national best bid/offer (NBBO) and any PFOF disclosures.
5. Compare across brokers using the same scenarios and include non-fee factors (platform, research, support).
6. Confirm after onboarding: check your first few statements and trade confirmations for unexpected charges.
Practical negotiation and cost-reduction tips
– Bundle services: negotiate lower fees if you consolidate assets or increase trading volume.
– Use limit orders: reduces slippage and can capture price improvements; note some brokers charge for certain order types.
– Choose the right account: some brokers waive fees for retirement accounts or high-balance households.
– Monitor promotions carefully: temporary zero-commission offers may not apply to all instruments and can change.
– Consider execution quality over the lowest headline fee: worse fills can cost more than a slightly higher commission.
Recordkeeping and tax notes
– Save trade confirmations and monthly statements for cost audit and tax basis calculation.
– When computing capital gains, include commissions in your cost basis for purchases and reduce
proceeds for sales.
Example — commission and capital gains
– Step 1 (purchase): You buy 100 shares at $50.00 = $5,000. Commission paid on purchase = $10.00. Purchase cost basis = $5,000 + $10 = $5,010.
– Step 2 (sale): You sell 100 shares at $60.00 = $6,000. Commission paid on sale = $10.00. Net sale proceeds = $6,000 − $10 = $5,990.
– Step 3 (gain): Taxable gain = net sale proceeds − purchase cost basis = $5,990 − $5,010 = $980.
– Compare: Ignoring commissions would give a $1,000 gain; commissions reduced the taxable and economic gain by $20.
How commissions affect investment returns
– Absolute effect: Commissions reduce the dollars you keep from a trade. The total commission cost = buy commission + sell commission (plus any per-contract or per-share fees for options).
– Percent effect: To see the commission’s impact, express commissions as a share of your invested capital. Example: $20 total commissions on a $5,000 trade = 0.4% cost. Smaller trades magnify this percentage.
– Break-even price move: For a long trade, the stock must rise enough to cover commissions. Break-even percent ≈ (total commissions) / (position value). In the example above, $20 / $5,000 = 0.004 = 0.4% required move to break even, before taxes and slippage.
Execution quality vs. headline commission
– Headline commission: The published fee per trade or per-share.
– Execution quality: How close your fill price is to the best available price; includes slippage (difference between expected and actual execution) and price improvement (getting a better price than displayed).
– Trade-off: A zero-commission broker that routes orders in ways that produce worse fills can cost you more than a modest commission with superior execution. Look at broker-disclosed execution statistics if you want to compare.
Practical checklist for trading commissions and costs
– Recordkeeping
1. Save trade confirmations and monthly statements.
2. Record commissions paid per trade; include them in your cost basis ledger.
3. Keep receipts for fees that affect basis (e.g., transfer fees, required reorg-related costs).
– Pre-trade
4. Calculate total round-trip cost (buy + sell commissions and fees) and express it as a percentage of trade size.
5. For small or frequent trades, consider whether fractional-share or commission-free offerings genuinely lower total cost.
– Order execution
6. Use limit orders if you want price control and can tolerate non-execution; use market orders when speed and certainty matter.
7. Check broker disclosures on order routing and payment for order flow (PFOF).
– Broker selection and negotiation
8. Compare effective cost (commissions + average slippage) across brokers, not just headline fees.
9. Ask brokers about volume discounts, account-equity waivers, and bundled-service pricing.
– Tax reporting
10. Confirm how your broker reports proceeds and basis on Form 1099-B and reconcile it with your records.
Worked numeric example — small trader sensitivity
– Trade A (small position): Buy 10 shares at $30 = $300. Commission round-trip = $10 + $10 = $20. Commission as % of trade = $20 / $300 = 6.67%.
– Trade B (larger position): Buy 1,000 shares at $30 = $30,000. Commission round-trip = $20. Commission as % of trade = $20 / $30,000 = 0.067%.
– Insight: Fixed commissions disproportionately penalize small trades; per-share pricing or zero-commission structures reduce that penalty.
Regulatory and disclosure notes
– Best execution: Brokers are required by regulators (U.S. Securities and Exchange Commission and FINRA) to seek the best reasonably available market terms for customer orders, considering price, speed, and likelihood of execution. Check broker disclosures on order routing and execution quality.
– Payment for order flow (PFOF): Some brokers receive payments from market makers for routing orders. PFOF can subsidize zero-commission trading but may create potential conflicts. Review the broker’s PFOF disclosures to understand whether and how it might affect your fills.
– Tax reporting: Brokers typically report proceeds and cost basis on Form 1099-B. You are ultimately responsible for reconciling your records and reporting gains or losses correctly.
When to prioritize low commission vs. execution
– Favor low commissions when:
– You employ a long-term buy-and-hold strategy with low turnover.
– You trade large block sizes where fixed fees are a minor percentage.
– Favor execution quality when:
– You trade frequently or use short-term strategies where slippage compounds.
– You trade illiquid securities where price improvement and routing materially affect fills.
Sources for further reading
– U.S. Securities and Exchange Commission — “Payment for Order Flow” https://www.sec.gov/fast-answers/answerspfofhtm.html
– Financial Industry Regulatory Authority (FINRA) — “Order Routing and Best Execution” https://www.finra.org/rules-guidance/key-topics/best-execution
– Internal Revenue Service — “Topic No.