What is a Commission?

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Definition:

A commission is a fee that a salesperson — like a stockbroker, real estate agent, or car salesperson — makes when he or she facilitates the sale of a product.

🤔 Understanding commissions

A commission is like a finders fee for salespeople like stockbrokers, real estate agents, and car salespeople. It’s one way that these professionals make an income by selling products. Depending on the industry, some people make a small portion of their income through commissions, while others rely on them heavily. In industries such as health insurance and real estate, sellers often pay the commission. In the case of investing, the client usually pays. Investors may want to look out for high commission rates from brokers and financial advisors, as these can eat into returns.

Example

Let’s say you’ve decided to start investing in mutual funds. You hire a commission-based broker to help facilitate a trade. Your broker charges a 2 percent commission. So if you invest $1,000, the deal actually costs you $1,020.

Let’s say you decide to sell your shares after five years. Suppose your $1,000 has grown to $1,500 over that time. With the 2 percent commission, you owe your broker $30 for the sale. In total, you’ve paid your broker $50 in commission fees to buy and sell shares.

Takeaway

A commission is like a referral bonus at your favorite retailer...

Many companies offer referral rewards: If you get a friend to sign up for their services, they’ll give you a bonus. It’s a win-win because you get a little extra cash, while your friend receives a service you already love. Commissions for brokers and real estate agents are similar, except it’s how some of these professionals make most of their income.

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What is commission-based pay?

A commission is an amount that an employee makes after facilitating the sale of a product or service.

Employees that get commission-based pay make at least some of their money from commissions. These jobs often come with a small base salary, and employees earn the rest of their incomes through the sales they make.

The percentage of an employee’s compensation that comes from a base salary versus commission differs based on the job. Some companies ensure that the base salary is enough for a living wage, while others expect salespeople to rely more heavily on commissions for their incomes. Some employees make their incomes entirely from commissions.

Employees might make a commission in one of two main ways:

  • Flat commission: Employees make the same amount per sale, regardless of its size. For example, when you buy insurance, your agent may make a flat commission based not on the cost of the sale but on the type of product.
  • Percentage-based commission: Employees earn a percentage of the transaction amount. In the case of real estate, for example, agents usually get paid a percentage of a home’s sale price.

In addition to commissions, employees can often earn bonuses when they help their company meet sales goals.

What are the pros and cons of commission-based pay?

Commission-based jobs can be a good fit for anyone who excels at sales, since the more you sell, the more money you make. This pay structure can also benefit companies because it often keeps overhead costs low while still rewarding hard work. Employees who rely on commissions may have the incentive to work harder and close more sales.

The downside of this payment model is that employees may struggle to make enough sales to make the job worthwhile. They may find it stressful to worry every month about making enough sales to pay the bills. Commissions can also lead to employees who are more concerned with making a sale than meeting the needs of customers.

Who gets paid commission?

Commission-based pay is a standard practice in some fields, usually ones with a substantial sales component.

Financial advisors

Financial advisors offer customized financial advice to their clients, including recommending securities and other investment options and managing investment portfolios.

While some financial advisors charge their clients a flat fee or a percentage of the assets they manage, others make their money from commissions. Commission-based advisors make their money on a per-trade basis or as a percentage of the monetary value of the securities products they sell. They also often earn a base salary from their employers.

One important thing to keep in mind is that while fee-based financial advisors must be fiduciaries (meaning they have a legal and ethical duty to act in your best interest), commission-based ones don’t have to be.

Real estate agents

Real estate agents who help clients buy and sell homes typically make their money on commissions. Most agents are self-employed, so they rely on clients rather than an employer to pay them commissions.

Sellers usually pay the commission, which is divided between the buyer’s and seller’s agents. Commissions for real estate agents are usually between five and six percent of the house’s selling price.

What is a trade commission?

A trade commission is a fee you pay your broker or financial services representative when you buy or sell a stock, exchange-traded fund (ETF), or another type of investment.

Trading commissions might apply per trade (meaning brokers get a flat fee when you buy or sell securities) or per share (meaning the broker’s commission depends on how much you’re buying or selling).

The investor buying and selling securities is usually the one to pay the commission. The amount of the commission varies from one brokerage firm to the next.

Suppose you call your broker and ask to buy shares of a particular stock for $500. If the broker charges a $5 trade commission, your total cost for the transaction would come to $505. If you were to sell those shares the next day, you would once again pay the $5 trade commission, which would come out of your profit.

What is commission-free trading?

Over the past few years, more brokerage firms have moved to commission-free trading for online transactions, meaning they don’t charge a commission to clients who buy and sell securities online.

The trend started when digital financial service providers began entering the industry and offering commission-free trading. By the end of 2019, most of the biggest brokerage firms had followed suit by offering commission-free options.

Some online brokerage firms don’t charge commissions on any of their products, while others offer certain products commission-free. (Robinhood does not charge any commissions across its stocks, exchange-traded funds (ETF), options and crypto trading tools.)

It’s important to remember that, just because a brokerage firm offers free trades, that doesn’t mean they offer their services for free. Instead, they make their money through other fees they charge customers.

For example, your broker might charge you a management fee or advisory fee, which is a fee you pay as a percentage of the assets they manage for you. Similarly you may have to pay an expense ratio, which is the annual fee that mutual funds and ETFs often charge investors.

How do you avoid commission fees?

When you’re investing your hard-earned money, you probably want to keep as much of it as possible. You don’t want a lot of it going toward commissions on your investments. The good news is that it's not difficult to avoid commission fees these days.

The alternative to paying commissions for investing is to work with an advisor who charges a flat fee or a percentage of the money invested. You can pay very low fees for the services of a robo advisor that uses an algorithm to help select your investments or higher fees for the personalized services of a financial advisor.

While you’re looking out for commission fees, you may want to pay attention to other costs you’re paying on your investments. Ask your broker about any management fees or expense ratios related to your investments.

Ready to start investing?
Sign up for Robinhood and get your first stock on us.Certain limitations apply

The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.

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