What are Broker Fees (and how to pay less)?
Picture a broker in your mind. What do you see?
Perhaps someone sitting behind a desk piled high of reports, talking on the phone, and watching huge columns of numbers scroll across a big computer screen. Maybe she's young and energetic. Maybe he's older and has seen it all. The whole scene tries to say "Trust me with your money. I know what I'm doing."
That's a good image, but it's incomplete. Most brokers are trustworthy and professional. Most are good at their jobs. Some are excellent. (As with any profession, a few—a handful really—are suspicious, but by far they mean well.)
Should you let someone else handle your money? Should you pay for the privilege of doing so?
That depends on what they charge for what you get in return.
Remember that the goal of investing is to make money. It sounds so simple. How could anyone forget? Yet it's easy to dig yourself into a hole before you've even had a chance to make money—and one way to start by losing money is to pay too much to invest.
What Are Broker Fees?
Note: The fees given here are examples and not absolutes.
Suppose your broker charges you a fee of 1% of your portfolio's value every year. (That's common.) If you have $10,000 invested, that's $100 a year. Your investments must make $100—1%—for you to break even on fees alone (let alone getting a good rate of return after taxes and inflation).
If you only earn $95, that means you've lost money. You might as well have put that money in a bank account where you could have earned $20 on it instead. Hopefully your broker's better than that and will help you break even. That doesn't always happen, and you'll have to pay brokerage fees either way.
The fees don't stop there. Suppose your broker charges you $20 every time you buy or sell something. If you have $10,000 invested and you sell one stock and buy another, that's $40 on top of the $100 already charged. Now you need to make $140 just to break even.
Is that reasonable? Maybe; you're not going to make those trades on your own. Then again, if you had a discount stock broker, you could pay $10 or less per trade.
Remember, you pay that commission for every transaction you make. Suppose your broker calls you with a great tip. A local company has gone through a restructuring and its stock looks like a bargain, as the business is solid, debt is gone, and revenue projections look great! You should transfer more money into your brokerage account and buy more stock!
Deposit another $1000 for that trade. You'll pay $20 for that transaction and another $10 in annual fees. For the additional $1000, you need to make a 3% return just to break even. If you sold something else to get that $1000, you paid $20 for that transaction too, so add up the costs again and again.
Yikes. If you've ever asked "How do brokers make money?", now you know—by charging you every chance they get.
Types of Brokers and Brokerage Fees
Not all stockbrokers are the same. Roughly speaking, there are three categories:
- Full-service brokers actively manage your portfolio for you. They may also provide tax advice, estate planning, and other financial services. In return, you generally pay a commission percentage of the trade value for every trade, generally 1 or 2%. In other words, buying or selling $4000 of stock could cost you $40 - $80. In addition, you may pay a 1 - 2% of your total assets in management fees every year.
- Discount brokers help you perform trades, but do not provide the range of services or personal advice you can expect from a full-service broker. Trade commissions are generally flat fees from $5 to $40 per trade. Any account maintenance fee is often less than 1% annually.
- Online brokers allow you to buy and sell securities online. You'll pay a flat fee per trade, often in the range of $5 - $15. There may be an annual fee, but it's generally less than $100 and frequently waived if you have enough assets invested.
The lines between these three categories can be fuzzy; an online discount broker may offer premium individual services, while still allowing you to manage your portfolio. In every one of these cases, you need to remember two things. First, you will pay to buy and sell stocks. Second, the amount you pay affects what you get in return.
How Do Fees Affect Your Return?
1% and 3% and 5% may not sound like a lot, but every dollar you give someone else to manage your money for you is a dollar that could be working for you. The S&P 500 has an 8% or 9% return rate on average over the past several decades. You'll have to beat that substantially to make up for these fees. Most brokers and most funds don't do better than that. Brokerage fees exist to make brokerages money, not to save you money.
There's nothing wrong with paying a professional to do a job you can't do yourself. If your broker is amazing and gets you 25% returns reliably, paying 3% in fees is well worth it. If your broker is good and makes a reliable 10% return before fees, you're just as well off not using a broker at all and instead dumping your money into an S&P 500 index fund, where you can make 8-10% a year.
Oh, and if your broker actively moves your money around—charging you $20 for each transaction, of course—paying a 3% brokerage fee might start to look like a bargain. Six transactions a year is $120. Ten transactions a year is $200.
Add to that that the broker doesn't necessarily know what you know about the businesses you want to invest in. Your broker's goals may not to be to find a couple of great companies and buy their stocks and hold them for several years. After all, if your broker makes money on every transaction, the fewer transactions you make, the less money for your broker.
Should You Pay a Stockbroker?
It's not fair to paint brokers as greedy—they're not—or anything other than professionals. Some of them are excellent and worth every penny they charge. Can brokers have it all? No; nor should you expect them too.
In theory, a full service broker is earning you enough every year that you will gladly pay individual transaction costs of $40 and up per trade and 1-2% of your assets every year. If you're getting a 20% return reliably, you write that check every year. That's great! That's rare.
In practice, most full-service brokers aren't providing that much extra value over simple index fund investing, unless you have a few million dollars in play. Even then, you can find tax assistance that charges you by the job, not a percentage of your portfolio.
Apart from estate or tax planning, you can do most of what a broker does for yourself. You can find great companies and good values and manage your investments on your own. You might get better returns than your investment broker could (in fact, if you're careful you're can pick a few winners!). Better yet, you'll understand your investments and be able to explain why you own the companies you own.
If you get a fair value from your broker, by all means continue to do so. If you're not sure, count the costs and see how much more work your money could do for you. You have options, from full-service to discount to online brokers, and you can save fees and put more of your money to work for you.