So you’re starting your investment journey and are researching brokerage accounts. It should be no surprise that brokers charge fees for their services. Let’s break down different types of brokerage fees and how they impact your investing.
A financial advisor can help you create a financial plan for your investment needs and goals.
What Are Brokerage Fees?
Brokerage fees are charges a broker applies for the work they do to handle your transactions. These can come from full-service brokers and online brokerages, and they are charges for sales, purchases and investment advice, among other services.
Whether you’re an active day trader or a passive long-term investor, these fees can eat into your investment return. So, knowing the what and why behind these fees is important.
How Brokerage Fees Work
Brokerages need to make money to stay running. After all, they offer valuable advice and services on behalf of their clients. However, broker fees can vary across brokerages and account and transaction types. The way brokerages charge fees can be a percentage on managed assets and fees per account, along with a commission on certain transactions. A lot depends on the type of brokerage.
Full-service brokers typically charge higher fees, but they offer more hands-on services. They’ll help you plan your retirement, recommend stocks that fit your goals and regularly analyze your portfolio. They’ll help you rebalance your portfolio when the time is right to make the most of the market. So, yes, their fees are higher, but they offer a lot for you to take advantage of.
Online brokerages, on the hand, often offer commission-free online trading for most stocks and exchange-traded funds (ETFs). Many also offer educational and research materials, but you’ll have to do the work yourself to make your own decisions.
Common Types of Brokerage Fees
Along with trading commissions, here are four common fees you should be familiar with:
- Mutual fund fees: Mutual funds have additional transaction fees when you buy/sell them.
- Expense ratio: Various funds, such as mutual funds, index funds and ETFs, charge an annual fee that’s a percentage of your investment.
- Assets under management (AUM) fees: These fees typically come from asset management firms, and they’re fees based on a percentage of total assets the firm is managing.
- Retirement plan fees: You may see an administrative fee for maintaining 401(k) plans.
How Do Brokerage Fees Impact Returns?
Brokerage fees can a significant effect on the amount of returns you see. If you’re an active trader, fees and commissions on transactions must be accounted for on trades and options. That’s because every time you’re taking action, a portion of your money could be going to a broker. But if you’re a long-term investor, even the slightest difference in annual account fees can make a huge difference.
For instance, let’s compare the difference between an annual account fee of 1% versus a 2% account fee. As an example, we’ll say your account has $50,000 in it. Let’s say it sees a 6% increase in one year. 6% would be $3,000, but the 1% fee turns into a 5% return, reducing your return to $2,500. A 2% fee would further reduce your return on $50,000 to $2,000.
The following year, the account with the 1% fee starts the year at $52,500. Let’s say that the market does really well and you see a return of 10%. After accounting for the fee, your account has grown to $57,225. On the other hand, the account with the 2% fee starts at $52,000 and, after accounting for the fee, ends the year at $56,160. That’s $1,065 less than the account with the 1% fee.
Over time, as these accounts compound growth, the account with a 1% annual fee will outpace the one with the 2% fee. Using our investment growth calculator and averaging for a 7% market return, the account with the 1% fee would be worth 89,542 in 10 years. The 2% account would be at $81,445, which is over $8,000 less.
However, this is only the case if the accounts average the same returns. A better-performing account may be worth the higher fee.
What Are Brokerage Fee Pros and Cons?
Contrary to what you may think, there are upsides and downsides to brokerage fees. Sure, a higher fee costs you more at face value. But if the services offered are worth it, it may make more sense to pay the higher fee. Here are a couple pros and cons:
- Higher return: If you’re paying more brokerage fees, you may be getting a better service. This service can result in a higher return on your investment, even when accounting for higher fees.
- More services and features: With brokerage fees, you can get more if you pay more. A full-service broker will charge more, but you’ll be able to leverage their experience and expertise. Online brokerages with higher fees may offer more tools to research your next trade.
- Lower return: As illustrated above, if an account with higher fees performs the same as an account with lower fees, you’re losing money.
- You don’t need the education: If you’re already financially savvy and have other places to go for answers, a brokerage with high fees may be redundant.
Brokerages provide a helpful service in guiding your investing. Whether they’re full-service brokers offering advice or online brokerages giving you the reins to research, you’re paying for them through brokerage fees. Brokerage fees come in many different forms, from asset management fees to commissions on transactions. No matter what they are, it’s important to understand how they work and gauge whether they’re worth it.
Tips for Investing
- A financial advisor can help guide you to make the right decisions with your money. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Before you start worrying about fees, decide on an investment strategy. Depending on how active or passive that strategy is, you can then research what types of brokerages will best serve the strategy and comparison-shop the different brokerage fees.
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