Definition of a Brokerage Fee
A brokerage fee, sometimes called brokerage, is compensation paid to a licensed broker serving as a knowledgeable intermediary in a transaction between two parties. The size of brokerage fees varies in relation to the size of the transaction in terms of the number of units, the total dollar value or both.
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How It Works
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Brokers and brokerage are most commonly understood in terms of the purchase and sale of financial assets. Investors solicit a broker when they wish to buy and sell items such as stocks and bonds. In addition to the actual transaction, the services provided by the broker may include, but are not limited to, expert advice and price hunting. These services are charged either as a percentage of the total transaction amount or as a function of the number of units.
Example
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To illustrate a possible brokerage fee structure, suppose a broker charges a fixed price of $20 up to 400 units with a marginal amount of $0.07 charged per additional unit beyond 400. An investor wishing to purchase 500 units (shares) of stock would be charged as follows:
($20 fixed for 400 shares) + $7 for 100 additional shares (100 * $0.07) = $27 in broker fees
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Types
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Brokerage fees are applicable where asset and insurance transactions are concerned. For this reason, real estate and insurance agents, in addition to securities brokers, charge brokerage fees on respective services and work related to the sale of homes and insurance policies. Real estate and insurance agents receive a brokerage fee related percentage-wise to the value of the home or policy sold.
Brokerage Fees vs. Commissions: Ethical Considerations
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In many cases, brokerage-type firms (investment houses and insurance agencies) offer their employees (brokers) commissions as an incentive for increasing sales revenues. Employees are rewarded with increasing compensation for sales above a given dollar amount. Ethics come into question in such circumstances, because brokers may become more focused on their own financial interests than the needs of their clientele.
In the absence of a commission structure, brokerage fees alone shift brokers' incentives from themselves to their clients. The essentially fixed nature of brokerage fees increases the necessity of providing quality service on an individual basis such that satisfied clients return again and again.
Implications for Investors
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Particularly at the consumer level, most investors have a definite amount of cash with which they may purchase assets such as stocks and bonds. When planning a portfolio strategy or allocating funds among various investments, investors should be aware of their broker's fee structure, as it may subtract from the total amount they are actually able to invest.
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References
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