Fixed commission: Meaning, Criticisms & Real-World Uses

What Is Fixed Commission?

A fixed commission is a set fee charged by a broker or financial institution for executing a transaction, regardless of the size or value of the trade. This type of fee structure falls under the broader category of brokerage fees within the financial markets. Historically, fixed commission rates were the standard for trading securities, ensuring a predictable income stream for brokerage firms. Today, while largely absent in mainstream equity trading for individual investors, the concept of a fixed commission can still be observed in certain specialized financial products or services. Such a fee stands in contrast to percentage-based commissions or other variable charges that fluctuate with the trade's value.

History and Origin

The practice of charging fixed commission rates has deep roots in the history of securities trading, particularly in the United States. The New York Stock Exchange (NYSE), for instance, was founded in 1792 with the Buttonwood Agreement, which included a principle of fixed-price commission, yielding roughly one percent to the broker. This system mandated that all broker-dealers charge their clients the same predetermined fee for transactions, regardless of the trade's size⁷, ⁸.

For nearly two centuries, this fixed commission structure remained largely unchallenged, providing stability and a predictable revenue stream for brokers. However, by the 1960s and early 1970s, growing dissatisfaction, particularly among institutional investors, began to challenge the system. Large pension funds and other major market participants sought lower transaction costs and began exploring "third market" and "fourth market" alternatives to bypass the NYSE's minimum prices. This external pressure, coupled with a broader push for deregulation, prompted the U.S. Securities and Exchange Commission (SEC) to act. In a landmark decision, the SEC mandated the complete abolition of fixed commission rates on May 1, 1975, a date widely known as "May Day." This pivotal regulatory change was aimed at fostering greater market competition and reducing trading costs for investors⁵, ⁶. The move led to significant shifts in the securities industry, encouraging innovation and new business models.

Key Takeaways

A fixed commission is a non-negotiable, flat fee for a transaction, irrespective of its size or value.
Historically, fixed commissions were standard in the U.S. securities industry, mandated by stock exchanges.
The U.S. Securities and Exchange Commission (SEC) abolished fixed commission rates on May 1, 1975, initiating a period of competitive commission pricing.
The transition away from fixed commissions spurred increased competition and reduced trading costs for investors.
While largely obsolete for mainstream stock and equity trading, fixed commission structures can still exist in niche financial services or products.

Formula and Calculation

A fixed commission, by its very nature, does not involve a complex formula. It is simply a pre-set amount charged per transaction.

For example, if a brokerage charges a \$5 fixed commission per trade, the commission paid is always \$5, whether the trade involves 1 share or 1,000 shares.

\text{Commission Paid} = \text{Fixed Rate per Transaction}

Where:

(\text{Commission Paid}) = The total amount of commission charged to the client.
(\text{Fixed Rate per Transaction}) = The predetermined, constant fee for each executed trade.

This straightforward calculation contrasts sharply with other fee structures, such as those based on a percentage of the trading volume or assets under management.

Interpreting the Fixed Commission

Interpreting a fixed commission is straightforward due to its unchanging nature. For an investor, a fixed commission means that the cost per trade remains constant, regardless of the number of shares bought or sold or the total monetary value of the transaction. This predictability can be advantageous for frequent traders or those dealing with smaller trade sizes, as the proportional impact of the commission decreases as the trade value increases.

Conversely, for very large trades, a fixed commission might represent a proportionally smaller cost compared to a percentage-based fee. However, for investors making small, frequent trades, the fixed commission can represent a significant percentage of the trade's value, thereby eroding potential returns. The U.S. Securities and Exchange Commission (SEC) emphasizes that all fees and expenses, including commissions, can significantly impact an investment portfolio's value over time⁴. Therefore, understanding how a fixed commission affects net returns is crucial for effective portfolio management and evaluating overall transaction costs.

Hypothetical Example

Consider an investor, Sarah, who uses a brokerage that charges a fixed commission of \$7 per stock trade.

Scenario 1: Small Trade
Sarah decides to buy 10 shares of Company X at \$50 per share.
- Value of shares purchased: 10 shares * \$50/share = \$500
- Fixed commission: \$7
- Total cost: \$500 + \$7 = \$507
Scenario 2: Large Trade
A week later, Sarah decides to buy 500 shares of Company Y at \$10 per share.
- Value of shares purchased: 500 shares * \$10/share = \$5,000
- Fixed commission: \$7
- Total cost: \$5,000 + \$7 = \$5,007

In both scenarios, despite the vast difference in the value of shares traded, the fixed commission remains constant at \$7. This illustrates how the fixed commission provides cost predictability for each individual trade, distinct from a variable fee structure. This can simplify calculating immediate transaction costs for investors.

Practical Applications

While no longer dominant for standard stock trades, the concept of a fixed commission still appears in various forms within the financial landscape:

Some Mutual Funds and ETFs: Certain mutual funds or exchange-traded funds may impose a flat "exchange fee" or a small, fixed "account fee" for specific actions, rather than a percentage of the transaction amount or assets under management.
Bond Transactions: In the bond market, particularly for odd lots or certain types of fixed-income securities, a flat fee per trade might be charged, distinct from the bid-ask spread.
Options Trading: While many brokers have moved to \$0 base commissions for options, a per-contract fee, which acts as a fixed commission per contract, is still common (e.g., \$0.65 per contract). Leading online brokers like Fidelity, Vanguard, and Schwab generally charge a per-contract fee for options trading, even if stock and ETF trades are commission-free³.
Specialized Brokerage Services: Some niche brokerage firms or full-service brokers might still employ fixed fees for certain manual or complex transactions that require significant human intervention.

Understanding these applications helps investors identify where fixed commissions might still impact their overall investment costs, especially when comparing different types of brokerage firms and their offerings.

Limitations and Criticisms

While fixed commissions offer predictability, they also come with inherent limitations and have faced significant criticism over time. A primary critique, particularly evident before 1975, was the disproportionate impact on smaller investors and institutions. Under a fixed commission system, a small investor trading a few shares paid the same flat fee as a large institutional investor executing a massive block trade. This effectively meant that smaller trades incurred a much higher percentage cost relative to their value, making investing less accessible and more expensive for those with limited capital. This disadvantage fueled calls for greater market competition and more equitable pricing structures².

Another criticism stemmed from the lack of pricing flexibility. Since all brokerage firms charged the same fixed commission, there was little incentive for brokers to compete on price, which could lead to reduced innovation and less pressure to offer more efficient services. The fixed commission environment was seen by some as fostering a comfortable, less competitive landscape for brokers, which could stifle efficiency and transparency within the securities industry ¹. The eventual abolition of fixed commissions was a direct response to these criticisms, aiming to foster a more dynamic and cost-effective market for all participants.

Fixed Commission vs. Negotiated Commission

The distinction between a fixed commission and a negotiated commission lies in how the fee for a transaction is determined and its variability.

Feature	Fixed Commission	Negotiated Commission
Fee Structure	A set, predetermined flat fee per transaction.	The fee is agreed upon between the client and the broker for each trade or series of trades.
Variability	Does not vary with the size or value of the trade.	Can vary based on trade size, value, client relationship, or specific services rendered.
Predictability	High predictability for individual trade costs.	Less predictable per trade, but allows for potential cost reduction through negotiation.
Market Impact	Historically led to higher proportional costs for small trades and less price competition among brokers.	Fosters price competition, often leading to lower effective costs, especially for large institutional trades.
Prevalence	Largely historical for mainstream equity trading, but still present in niche areas (e.g., some options fees).	Dominant model in modern equity and institutional trading.

Historically, the fixed commission system meant that all brokers charged the same rate, limiting price discovery and favoring larger trades proportionately. The shift to negotiated commission structures, sparked by the SEC's "May Day" ruling in 1975, revolutionized the financial markets. It introduced significant price competition among broker-dealers, leading to a dramatic reduction in transaction costs for investors over time. Today, the vast majority of stock and exchange-traded funds transactions for retail investors are effectively commission-free, a direct evolution from the era of negotiated commissions.

FAQs

What is the primary difference between a fixed commission and a percentage-based commission?

The primary difference is how the fee is calculated. A fixed commission is a flat, unchanging fee per trade, regardless of the transaction's size or value. In contrast, a percentage-based commission is calculated as a proportion of the total value of the assets traded, meaning the fee will increase or decrease with the size of the trade.

Why did fixed commissions become obsolete for most stock trading?

Fixed commissions became largely obsolete for mainstream stock trading due to regulatory changes and a push for greater market competition. In the U.S., the SEC's abolition of fixed rates in 1975 ushered in an era of negotiated commissions, which significantly reduced transaction costs for investors and fostered innovation among brokerage firms.

Are there any situations where fixed commissions are still used?

Yes, while rare for typical stock trades, fixed commissions can still be found in certain areas. Examples include per-contract fees for options trading, some bond transactions, or specific account service fees charged by a brokerage firm. Certain mutual funds may also have fixed exchange fees.