What Is the Five Percent Rule?
The five percent rule is a stipulation of the Financial Industry Regulatory Authority (FINRA), which oversees brokers and brokerage firms in the U.S. Dating back to 1943, it stipulates that abroker shouldn’t charge commissions, markups, or markdowns of more than 5% on standard trades, both stock exchange listings and over-the-counter transactions, along with proceeds sales and riskless transactions.
Although also known as the FINRA5% markup policy or 5% policy, the five percent rule is more of a guideline than an actual regulation. The aim is to require brokers to use fair and ethical practices when setting commission rates, so that that the prices investors pay are reasonably related to the market for the securities they buy.
Key Takeaways
- The five percent rule, aka the 5% markup policy, is FINRA guidance that suggests brokers should not charge commissions on transactions that exceed 5%.
- The five percent rule is more of a guideline than an actual regulation, aiming to ensure that investors pay reasonable commissions and that brokers are ethical in setting their fees.
- In the context of investing, the five percent rule may also refer to the practice of not letting any single security or asset comprise more than 5% of a portfolio.
How the Five Percent Rule Works
The five percent rule itself does not set forth any criterion for calculating commissions or fees. Instead, it indicates that the broker should follow guidelines. The rule is applied to various transactions, including the following:
- Principal transactions: A broker-dealer buys or sells securities from its own holdings and, based on that,charges a markup or markdown.
- Agency transactions: A brokerage firm, acting as a middleman, charges a commission on a transaction.
- Proceeds transactions: A broker-dealer sells a security for a client and uses those proceeds to purchase other securities. This constitutes one transaction, not two.
- Riskless transactions: Such simultaneous transactions seea firm buy a security from its own holdings and immediately sellit to acustomer.
The rule itself has several exceptions. For example, it does not apply to securities sold through a prospectus—such as in an initial public offering.
What Determines a Fair Commission?
If the five percent rule aims to establish a reasonable fee, it's natural to wonder: How do firms determine what's fair? Elements that are considered when determining what is fair and reasonable include:
- The price of thesecurity in question
- The total value of the transaction (larger transactions may qualify for discounted pricing)
- What kind of security it is (options and stocks transactions have higher costs than bonds, for example)
- The overall value of the members' services
- What it cost to execute the transaction (some firms impose a minimum transaction)
It should be noted that each factor may contribute to a higher or lower commission than 5%; a large equity transaction that was simple to execute may be done so for far less than 5%, while a small, complicated transaction of a more lightly traded security could be far more than 5%.
Five Percent Rule Example
If a client wanted to buy 100sharesof Hypothetical Co. at $10 a share, the total value of that transaction would be $1,000. If the broker's minimumtransaction cost was $100, the total fee would be 10% of the trade—far more than the five percent rule. However, as long as the client knew of the transaction minimum in advance, the rule would not apply.
Special Considerations
The five percent rule also has another meaning. In the context of investing, it may also refer to the practice of not allocating more than 5% of a portfolio to any single security—in other words, of not letting any one mutual fund, company stock, or even industrial sector to accumulate to comprise more than 5% of the investor's overall holdings. This sort of five percent rule is a yardstick to help investors with diversification and risk management.
FAQs
What is the Five Percent Rule? In investment, the five percent rule is a philosophy that says an investor should not allocate more than five percent of their portfolio funds into one security or investment.
What is the 5% rule renting vs buying? ›
Now, at least as a simple example from PWL, we can compare the unrecoverable expenses of renting versus owning. Take the worth of the home you're thinking about, multiply it by 5%, and divide it by 12 months. Renting may be a good financial decision if you can get a place for less than that.
What is the Finra 5% rule? ›
FINRA Rule 2121, also known as the 5% rule or 5% policy, was adopted to ensure that the investing public receives fair treatment and is charged reasonable rates for brokerage services. The 5% rule is more of a guideline than a rule, as there is no set limit for the amount you can charge as a markup.
What is the 5x rule for mortgages? ›
The 5x Rule:
It's rare, but sometimes borrowers qualify for mortgages up to 5-times their annual income. This is usually the case for people who've paid off all major loans and are basically debt-free. However, it does not mean you should maximize and get a home loan for that amount.
What is the 10 5 3 rule? ›
The 10,5,3 rule
Though there are no guaranteed returns for mutual funds, as per this rule, one should expect 10 percent returns from long term equity investment, 5 percent returns from debt instruments. And 3 percent is the average rate of return that one usually gets from savings bank accounts.
Is the 1% rent rule realistic? ›
The 1% rule is a guideline that real estate investors use to choose viable investment options for their portfolios. Although the rule has helped many investors make wise decisions regarding their investment properties, the current real estate market may make following the 1% rule unrealistic.
What is the 7% rule in real estate? ›
The top 7% are hustlers. If they don't know something, they'll learn it. If the heat is on, they'll put in the extra hours to make it happen. You don't have to know everything, everyone, have all the money, or talent, but if you'll apply those two principles, you'll do very well in real estate.
What does the finras 5% markup policy not apply to? ›
FINRA's guidelines, which require all prices paid by customers to be reasonably related to a security's market price. The 5 percent policy is a guideline, not a rule, and does not apply to securities sold through a prospectus.
Who does the 5% markup policy apply to? ›
The 5% Markup Policy covers all transactions except municipal bonds and those requiring a prospectus (e.g., the sale of a new issue, mutual funds, and registered secondaries). A member acting as an underwriter would be involved in a new issue and, if acting as a sponsor, would be involved in the sale of a mutual fund.
What is the FINRA red flag rule? ›
The Red Flags Rule requires specified firms to create a written Identity Theft Prevention Program (ITPP) designed to identify, detect and respond to “red flags”—patterns, practices or specific activities—that could indicate identity theft.
Let's say you earn $70,000 each year. By using the 28 percent rule, your mortgage payments should add up to no more than $19,600 for the year, which equals a monthly payment of $1,633. With that magic number in mind, you can afford a $305,000 home at a 5.35 percent interest rate over 30 years.
Is the 28 36 rule realistic? ›
Bottom line. Much like any other rule of thumb, the 28/36 rule is a guideline but not a hard-and-fast rule when it comes to getting approved for a mortgage. Borrowers can use this rule to help improve their financial standing before applying for a mortgage.
How much income do I need for a 500k mortgage? ›
Considering that most lenders want you to keep your housing expenses at or under 30% of your gross income, you'd need to earn at least $152,000 a year to afford that $500,000 home.
What is the 5 10 15 1 rule? ›
Intermede Investment Partners employ a "5-10-15" rule when investing. "Five refers to a minimum 5% a year revenue growth, on average, annually. 10% is the annual EPS growth that we're looking for. And 15% is the ROE minimum threshold," explains Intermede CEO Barry Dargan.
What is the 10 5 or 15 5 rule? ›
The 10 and 5 rule is a simple guideline that is widely used in the hospitality industry. The rule dictates that when a staff member is 10 feet from a guest, the staff smiles and makes direct eye contact, and when they are within five feet, the staff verbally greets the guest.
What is the 10 5 2 rule? ›
The idea behind the 10:5 rule is that anytime you find yourself within 10 feet (3 meters) of someone, you should smile and make eye contact. When you are within 5 feet (1.5 meters) of someone, you should greet them with a friendly hello or other greeting.
What is the 50% rule in rental property? ›
The 50% rule or 50 rule in real estate says that half of the gross income generated by a rental property should be allocated to operating expenses when determining profitability. The rule is designed to help investors avoid the mistake of underestimating expenses and overestimating profits.
At what point is renting better than buying? ›
A ratio of 15 or lower generally means it's better to buy, while 21 or higher means it's better to rent. Three California metros with very expensive homes – San Jose, San Francisco and Los Angeles – had the largest average gap between renting and buying in 2023.
What is the 10% rule for rental properties? ›
This rule is basically to avoid paying the sticker price. Instead, look to buy at least 10% under the listed price. In real estate, there's a saying that most of the return is made at the time of purchase. Meaning that most of the money is made on the purchase rather than rental income.
Is it better financially to rent or buy a house? ›
Renting is usually cheaper in the short term, and it's ideal for those who live in high-cost areas or need flexibility. Owning is more expensive upfront and requires more commitment, but it's often more financially rewarding in the long run.
