When an investor purchases or sells shares of stock, the price paid may include two components: the cost of the shares and any fee charged by the brokerage firm that makes the transaction. This fee is called the commission.
Online brokers have been caught in an all-out price war lately. Many major online brokers offer zero commission trades on stocks, though most charged a commission for trading mutual funds.
Key Takeaways
- Shares of a new stock issue such as an initial public offering (IPO) are sold directly by the company at a set price, mostly to large financial institutions and insiders.
- Most of those shares are then listed for sale on a stock exchange where anyone may buy or sell them.
- From that point, market sentiment and the company's performance determine the share price.
Most full-service brokers charge 1% to 2% of the total purchase price, a flat fee, or a combination of both, for stock purchases. They offer investors financial planning and investing advice as well as making transactions for clients.
Understanding Share Prices
The price of a share of stock is determined in one of two ways:
Newly-issued stock shares can be purchased only on the primary market for a non-negotiable price set by the company that issues them. For example, a young company that decides to go public to raise money may determine that $15 is a fair price for its shares. It issues a predetermined number of shares at this set price for a limited amount of time. Most of these shares will be purchased by large institutional investors and insiders and will then be resold on the open market.
This is an initial public offering(IPO).
Those early buyers will then list most or all of their shares on the open market, where anyone with a brokerage account can buy and sell them. At that point, the shares will rise (or fall) to the level that investors consider to be their true value.
That is the so-called secondary market made up of stock exchanges such as the New York Stock Exchange and the Nasdaq.
For as long as the company remains public, investor sentiment and market psychology will determine the stock price from minute to minute.
Broker Commission
The second component of a share purchase price is the broker commission, if any. Individual investors may buy and sell stock through an online broker or a full-service broker while larger institutional investorsmay work with an investment bank.
Full-service brokerage fees vary from broker to broker. Some charge a flat rate, ora nominal rate per share, while others may charge a percentage of the total trade value, and some charge a combination of both.
As noted, many online brokers have dispensed with fees for buying and selling stock shares and exchange-traded funds in this highly competitive environment. They may charge fees for other transactions, including purchases and sales of mutual funds, bonds, and futures. Most also now offer premium services such as personal financial advice and customized portfolios for a fee.
Example of Share Purchase Fees
Assume an investor wants to purchase 100 shares of stock in company ABC. This is a listed company, not an IPO, so the shares must be purchased on a stock exchange for the current market price of $20 per share.
Online brokers are giving stock investors a free ride for now. Other investments such as mutual funds will carry a fee.
If the investor uses an online broker, the price will be $2,000. If a full-service broker is used, there will be a fee of 2% of the total trade value, with a minimum commission of $50. The total price of the shares alone is $20 * 100, or $2,000. The commission is $2,000 * 2%, or $40. Since the commission rate is lower than the minimum, the online broker charges the flat $50 brokerage fee, bringing the total price of the share purchase to $2,050.
When it comes to investing in stocks and understanding the dynamics behind stock prices and brokerage fees, I've got you covered. Let's break down the concepts mentioned in this article.
Stock Purchase Process:
1. Primary Market vs. Secondary Market:
- Primary Market: This is where newly issued stocks, like IPOs, are sold by companies directly to large financial institutions and insiders at a set price determined by the issuing company.
- Secondary Market: Once the initial purchasers sell these shares on stock exchanges (like NYSE or Nasdaq), they're available to anyone with a brokerage account. Here, the stock's price fluctuates based on market sentiment and the company's performance.
2. Determinants of Share Prices:
- In the secondary market, share prices are determined by investor sentiment and market psychology, continually fluctuating based on perceived value.
Brokerage Fees:
1. Commission Structure:
- Full-Service Brokers: They charge fees (usually 1% to 2% of the total purchase price) and offer additional services like financial planning and advice along with executing transactions.
- Online Brokers: Many have moved to zero-commission trades for stocks but might charge for other transactions like mutual funds, bonds, and futures.
2. Calculating Fees:
- Example Calculation: Let's say an investor wants to buy 100 shares of a listed company at $20 per share.
- For an online broker with zero commission, the cost would be $2,000 (100 shares * $20 each).
- For a full-service broker with a 2% commission and a minimum fee of $50, the fee would be $40 (2% of $2,000), but since it's below the minimum, the broker charges the flat $50 fee, making the total cost $2,050.
Key Takeaways:
- New Stock Issues: IPOs are sold at a set price on the primary market, then traded on stock exchanges based on market demand and company performance.
- Brokerage Trends: Online brokers often provide zero-commission trades for stocks but might charge for other investments. Full-service brokers offer additional services but charge higher commissions or fees.
Understanding these dynamics is crucial for investors to make informed decisions about where and how to buy stocks and the associated costs.
