Understanding Brokerage Fees: A Guide for Traders and Investors

Last Updated: 8 January 2024

Trading and investing fees can significantly impact returns. However, with the rise of low-cost online brokerages, fees have declined substantially in recent years. This guide examines the major fee types charged by brokers and provides tips for minimizing costs.

Major Brokerage Fee Types

Trading Commissions

This refers to a fee charged per trade. Commissions were once the primary source of broker revenue, but have declined precipitously.

  • Stock and ETF commissions are now $0 at most major brokers.
  • Options commissions remain, but are as low as $0.50 per contract.
  • Futures commissions vary based on contract size and can be as low as $0.85 per side.

Account Maintenance Fees

An ongoing fee charged for having an account. This is rare at online discount brokers.

Inactivity Fees

A periodic fee charged when accounts are dormant, with no trading activity.

  • Typical inactivity fees are $10 per quarter.
  • Easy to avoid with even minimal trading volume.

Miscellaneous Fees

Less common fees like wire transfer fees, paper statement fees, etc.

  • Mostly avoidable by utilizing electronic transfers and online documents.
  • Read the fee schedule closely when opening an account.

Trading Costs

Beyond straightforward fee schedules, it’s important to understand the trading costs for various products.

Bid-Ask Spread

The difference between the price buyers are willing to pay (bid) and the price sellers are willing to accept (ask). This spread represents trading costs.

  • Spread capture is a major source of revenue for brokers.
  • Spreads are tightest for highly liquid products like S&P 500 stocks.
  • Less liquid products like small cap stocks have wider spreads.

Expense Ratios

Annual fee charged by mutual funds and ETFs to cover operating expenses.

  • Passive index funds have expense ratios below 0.10%.
  • Actively managed funds often exceed 1%.

Slippage

The difference between the expected price of a trade and the actual execution price. This occurs during periods of volatility.

  • Can be avoided by using limit orders instead of market orders.
  • Mostly affects larger trades in smaller companies.

How Brokers Make Money

Understanding how brokers generate revenue provides context for their fee structures.

Interest on Cash Balances

Brokers provide a return on idle cash, but it is lower than rates from banks.

  • Schwab and Fidelity pay around 0.40% as of 2023.
  • This provides billions in revenue for major brokerages.

Payment for Order Flow

Brokers receive payment from market makers for directing trades to them.

  • Benefits brokers through revenue sharing.
  • Benefits traders through price improvement.

Margin Interest

Interest charged to traders who borrow funds for leverage.

  • Margin rates vary based on account size and balance.
  • Major brokers charge 9-10% on margin loan balances.

Strategies for Minimizing Fees

While fees have declined overall, investors should still utilize strategies to reduce costs further.

Open Accounts at Discount Brokers

Avoid fees from full-service brokers by using low or no fee alternatives.

  • Leading discount brokers include FidelitySchwabVanguard and TD Ameritrade.
  • Savings can amount to hundreds per year in commissions.

Use Passive Index Funds

Choose ETFs and index mutual funds over actively managed counterparts.

  • Passive funds have expense ratios below 0.10%.
  • Actively managed funds often exceed 1%.

Avoid Small or Illiquid Securities

Prioritize trading large cap stocks with high liquidity.

  • Small caps and thinly traded securities have wider spreads.
  • Larger spreads represent indirect trading costs.

Minimize Speculative Trading

Excessive trading generates commissions and tax obligations.

  • Buy-and-hold strategies avoid recurring commission fees.
  • Tax-advantaged accounts shield activity from taxes.

Evaluating a Broker’s Fees

Choosing a broker involves analyzing fees across products traded.

Asset Class What to Evaluate
Stocks and ETFs Commissions, margin rates
Options Per contract commissions, margin rates
Mutual Funds Transaction fees, expense ratios
Fixed Income Bond commissions, CD commissions

Stock and ETF Fees

Compare commissions and margin interest rates.

  • $0 stock and ETF commissions are now standard.
  • Margin rates range from around 8-10% APR.

Options Fees

Look at per contract commissions and margin rates.

  • $0.50 per contract is common.
  • Margin can be 20% of stock price or higher.

Mutual Fund Fees

Assess transaction fees and fund expense ratios.

  • No-transaction-fee (NTF) funds avoid fees.
  • Index funds offer lowest expense ratios.

Fixed Income Fees

Review commission schedules for bonds and CDs.

  • $1 per bond is common.
  • CD commissions are rarely over $50.

Conclusion

While trading costs have fallen across the board, investors should remain vigilant by utilizing low-cost instruments, minimizing speculative trading, and thoroughly evaluating broker fee schedules. The savings from reduced fees will directly boost net returns over time.

Key Takeaways

  • Major fee types include commissions, account fees, and inactivity fees.
  • Trading costs like bid-ask spreads and slippage affect returns.
  • Brokers generate revenue through cash balances, payment for order flow, and margin interest.
  • Choose discount brokers, passive funds, larger stocks, and buy-and-hold strategies.
  • Compare fees thoroughly across asset classes when selecting a broker.
  • Reduced fees directly translate to improved net returns.
Author
  • Florian Feidenfelder

    Florian Feidenfelder is a seasoned cryptocurrency trader and technical analyst with over 10 years of hands-on experience analyzing and investing in digital asset markets. After obtaining his bachelor's degree in Finance from the London School of Economics, he worked for major investment banks like JP Morgan, helping build trading systems and risk models for blockchain assets.

    Florian later founded Crypto Insights, a leading research firm providing actionable intelligence on crypto investments to hedge funds and family offices worldwide. He is the author of the bestseller "Mastering Bitcoin Trading" and has been featured in prominent publications like the Wall Street Journal, Bloomberg, and Barron's for his insights on blockchain technologies.

    With extensive knowledge spanning the early days of Bitcoin to today's explosive DeFi landscape, Florian lends his real-world expertise to guide both new entrants and seasoned professionals in capitalizing on the wealth-creating potential of crypto trading while effectively managing its inherent volatility risks.

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