Flat commission

What Is Flat Commission?

A flat commission is a fixed fee charged for a transaction, regardless of the transaction's total value or size. This stands in contrast to percentage-based commissions, which fluctuate with the value of the underlying asset or trade. Flat commissions are a common feature in the financial services industry, particularly in brokerage and real estate, and fall under the broader category of investment fees.

This type of fee structure aims to provide transparency and predictability for clients, as the cost of a service is known upfront. Flat commissions can be applied to various transactions, from buying and selling securities to specific advisory services. Such fees are an important consideration in portfolio management, as they directly impact net returns for investors²³, ²⁴.

History and Origin

Historically, fixed commission rates were the norm in the U.S. securities industry. For centuries, since the Buttonwood Agreement of 1792, brokers charged a non-negotiable, fixed commission on stock transactions. This meant that whether an investor bought 100 shares or 10,000 shares, the commission per share or per lot could remain constant, without discounting for larger orders²².

This system faced increasing scrutiny over time due to concerns about competition and fairness, particularly regarding institutional investors versus individual investors²¹. A pivotal moment arrived on May 1, 1975, often referred to as "May Day," when the Securities and Exchange Commission (SEC) formally abolished fixed commission rates through Rule 19b-3¹⁹, ²⁰. This decision mandated competitive, negotiated commission rates, marking a significant shift towards market-driven pricing in brokerage services. Within weeks, commissions reportedly dropped by half¹⁸. The move paved the way for the rise of discount brokerages, which offered lower trading costs to investors.

Key Takeaways

• A flat commission is a fixed fee charged for a transaction, irrespective of its size or value.
• This fee structure provides cost predictability for investors and clients.
• The abolition of fixed commissions in the U.S. on "May Day" 1975 ushered in an era of competitive, negotiated rates.
• Flat commissions directly impact investment returns and should be considered in financial planning.

Formula and Calculation

The calculation for a flat commission is straightforward, as it is a set amount. There is no complex formula, as the fee does not depend on variables like trade size or asset value.

$\text{Total Cost} = \text{Asset Price} + \text{Flat Commission}$

Where:

• Asset Price = The price of the asset being bought or sold.
• Flat Commission = The predetermined fixed fee.

For instance, if a brokerage charges a flat commission of $5 per trade, the cost remains $5 whether you buy one share or one thousand shares. This differs significantly from an ad valorem fee, which is based on a percentage of the value.

Interpreting the Flat Commission

Interpreting a flat commission involves understanding its impact relative to the size of the transaction. For smaller transactions, a flat commission can represent a significant percentage of the total transaction value. Conversely, for larger transactions, the same flat commission becomes a proportionally smaller cost. This makes flat commissions particularly attractive for active traders or investors dealing in large volumes, as the per-unit cost of the commission decreases as the transaction size increases.

When evaluating an investment, investors should compare flat commissions to other fee structures, such as expense ratios found in mutual funds or exchange-traded funds (ETFs) and management fees charged by financial advisors. The choice between a flat commission and a percentage-based fee can significantly influence the net return of an investment strategy, particularly over the long term.

Hypothetical Example

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

Scenario 1: Sarah buys 10 shares of Company A at $100 per share.

• Value of shares: 10 shares * $100/share = $1,000
• Flat commission: $7
• Total cost: $1,000 + $7 = $1,007
• Commission as a percentage of transaction value: ($7 / $1,000) * 100% = 0.70%

Scenario 2: Sarah buys 100 shares of Company B at $100 per share.

• Value of shares: 100 shares * $100/share = $10,000
• Flat commission: $7
• Total cost: $10,000 + $7 = $10,007
• Commission as a percentage of transaction value: ($7 / $10,000) * 100% = 0.07%

As this example illustrates, the flat commission of $7 remains constant, but its relative impact on the transaction cost decreases significantly as the value of the trade increases. This highlights how a flat commission can be more cost-effective for larger transactions compared to a percentage-based commission.

Practical Applications

Flat commissions are prevalent in several areas of finance:

• Online Brokerages: Many online brokerage platforms now offer flat fees per trade for stocks, options, and ETFs. This model has gained popularity, particularly with the rise of discount brokers. Some even offer "zero-commission" trading, though other fees or revenue streams may still exist¹⁷.
• Real Estate: Real estate agents may sometimes charge a flat fee for their services, especially for selling properties, as an alternative to the more common percentage-based commission on the sale price.
• Advisory Services: Certain financial advisors or robo-advisors might charge a flat annual fee for portfolio management or financial planning, rather than a percentage of assets under management (AUM).
• Tariffs and Trade: In international trade, a fixed fee per unit of a good, rather than a percentage of its value, can be considered a form of flat commission. For example, some tariffs are set at a fixed cost per liter rather than a percentage¹⁴, ¹⁵, ¹⁶. This can also be seen in some instances where black market currency trades are executed with no middleman or commission¹³.
• Regulatory Fees: The SEC also charges a small "Section 31 Transaction Fee" to exchanges and broker-dealers on the sale of exchange-listed equities, which is then often passed on to investors. This fee is calculated based on the volume of shares traded and is a fixed amount per million dollars of sales, rather than a percentage of each individual transaction¹⁰, ¹¹, ¹².

The widespread adoption of flat commission structures in various industries reflects a shift towards more transparent and predictable pricing models.

Limitations and Criticisms

While flat commissions offer predictability, they are not without limitations or criticisms:

• Disproportionate Impact on Small Transactions: For small trade sizes or investments, a flat commission can represent a substantial percentage of the total transaction value. This can make frequent small trades uneconomical and may deter small investors or those engaging in dollar-cost averaging with limited funds. The cumulative effect of fees, even small ones, can significantly erode investment returns over time⁶, ⁷, ⁸, ⁹.
• Lack of Incentive Alignment (in some cases): In scenarios where flat commissions are applied to services like real estate or advisory fees, some critics argue that they might not always align the professional's incentive with maximizing the client's outcome. For example, a real estate agent on a flat fee might have less financial incentive to negotiate a higher sale price compared to one earning a percentage of the sale.
• Potential for Hidden Costs: Even with a flat commission, other fees may still apply, such as exchange fees, regulatory fees (like the SEC's Section 31 fee), or inactivity fees⁴, ⁵. Investors must examine the full fee schedule to understand the total cost of ownership or transaction.
• Less Competitive for Large Transactions (Historically): Prior to May Day 1975, fixed commissions were criticized for not offering discounts on larger orders, even though the actual execution costs did enjoy economies of scale³. While modern flat commissions generally benefit larger transactions proportionally, the historical context highlights a criticism of fixed fee structures when market forces are suppressed.

The Securities and Exchange Commission (SEC) continues to monitor and adjust fees to ensure fair practices and protect investors, frequently issuing advisories and adjusting fee rates¹, ².

Flat Commission vs. Percentage-Based Commission

The primary distinction between a flat commission and a percentage-based commission lies in how the fee is calculated.

A flat commission offers simplicity and transparency, as the cost per transaction is constant. This can be advantageous for frequent traders or those dealing with large sums, as the commission becomes a smaller percentage of the overall transaction value. Conversely, for smaller transactions, a percentage-based commission might be more cost-effective as the fee scales down with the transaction value. Understanding these differences is crucial for investors and consumers to choose the fee structure that best aligns with their investment goals and trading activity.

FAQs

What is the main advantage of a flat commission?

The main advantage of a flat commission is its predictability and transparency. Investors know the exact cost of a transaction upfront, regardless of its size, which can simplify financial planning.

When is a flat commission most beneficial for an investor?

A flat commission is most beneficial for investors who execute larger transactions or trade frequently. In these cases, the fixed fee represents a smaller percentage of the overall transaction value, leading to lower effective costs per unit compared to a percentage-based fee.

Are all brokerage accounts now commission-free?

While many online brokerages have moved towards "zero-commission" trading for stocks and ETFs, not all brokerage accounts are entirely commission-free. Other fees, such as regulatory fees, exchange fees, or fees for specialized services, may still apply. It is important to review a brokerage's complete fee schedule.

How do flat commissions affect long-term investment returns?

Like all fees, flat commissions reduce net investment returns. While a single flat fee may seem small, its cumulative impact over many transactions and over long periods can significantly diminish the overall growth of a portfolio. Investors should always consider the total cost of investing.

Can flat commissions be negotiated?

Generally, published flat commission rates from large online brokerages are non-negotiable. However, for certain bespoke financial advisory services or in specific market segments like real estate, there may be some room for negotiation, depending on the service provider and the scale of the engagement.