How brokers are compensated for selling bonds depends on the capacity in which they are acting in the transaction. Most bond transactions are originated by a brokerage dealer, which can act as a principal if it sells bonds from its own inventory, or it can act as an agent when it buys or sells bonds on the open market on a client's behalf. The firm is compensated differently in each case.
Selling Bonds As a Principal
Many broker-dealers keep inventories of bonds that they purchased through public offerings or on the open market. Because the broker-dealers own the bonds, they can mark up the prices when they are sold, which means the bond buyer pays a price that is higher than what the firm paid to purchase the bond. Markups are a legitimate way for broker-dealers to make a profit. Clients are not privy to the broker-dealer's original transaction, so they have no way of knowing how big of a markup they are paying or even if they are paying any markup. In many instances, clients purchase bonds from a broker-dealer under the impression that there is no cost other than a small transaction fee.
The issue for clients is that they won't know how much compensation the broker-dealer received for the transaction because the firm is under no obligation to disclose that information. To the client, it may appear as though no commissions are charged because the transaction is recorded at markup price. The extent of a markup can vary widely from one firm to the next, and each broker has complete discretion as to how much it marks up or marks down a bond’s price on any transaction. However, if a client purchases a bond as a new issue, everyone pays the same price for it, because the broker-dealer's markup is included in the par value price of the bond, and there are no separate transaction costs.
Selling Bonds As an Agent
When a client wants to buy a bond that is not owned by the broker-dealer, the purchase has to take place on the open market. In this capacity, the firm acts as an agent for the client to buy the bond, for which it charges a commission. The commission can range from 1 to 5% of the market price of the bond. Commissions earned by the broker-dealer must be disclosed to the client when the transaction is confirmed.
Shop and Compare Bond Transaction Costs
Investors do have a choice when buying bonds that can be purchased from a number of different sources. The bigger brokerage firms or wirehouses generally have the largest inventories of bond issues, but it is difficult to compare transaction costs because they are not required to disclose them. You may be able to compare your purchase price for the bonds with the actual price paid by the firm at InvestingBonds.com, which reports all information related to bond transactions on a daily basis.
You can purchase bonds on the open market through any securities firm, including discount brokerages, such as Charles Schwab, and online brokerages, such as E*Trade. Depending on the particular bond issue, many of the discount and online brokerages may charge a flat fee for the transaction. Because they are acting as an agent for the transaction, they are required to disclose all fees or commissions prior to the transaction.
There is always a transaction cost when you invest in bonds. Before you invest in a bond, do your homework and ask questions of your broker to determine if the costs that he is charging you are reasonable and fair.
FAQs
Selling Bonds As an Agent
How are broker-dealers compensated? ›
One of the main ways broker-dealers make money is through brokerage fees. These are fees charged for executing trades for clients. A brokerage fee can be calculated in a few different ways. Some fees are a flat fee per transaction.
Do bond brokers make a lot of money? ›
The average Bond Broker in the US makes $87,328. Bond Brokers make the most in San Jose, CA at $172,419 averaging total compensation 97% greater than US average.
Do brokers make money on Treasury bills? ›
Some firms charge a small fixed service fee—which they probably view as a loss leader to keep your money with them— to procure the bonds at auction (such as with Treasuries bills and other money market securities). Brokerage firms are paid a “concession” (which you never see) by the issuer on newly issued bonds.
What happens when investors sell bonds? ›
In general, when interest rates go down, bond prices go up. If this happens, you can make money by selling your bond before it matures. You'll get more than you paid for it, and you'll keep the interest you've made up until the time you sell it.
What is the commission of a bond broker? ›
Selling Bonds As an Agent
In this capacity, the firm acts as an agent for the client to buy the bond, for which it charges a commission. The commission can range from 1 to 5% of the market price of the bond. Commissions earned by the broker-dealer must be disclosed to the client when the transaction is confirmed.
What percentage do most brokers take from agents? ›
A common commission split gives 60% to the agent and 40% to the broker, but the split could be 50/50, 60/40, 70/30, or whatever ratio is agreed by the agent and the broker. It is common for more experienced and top-producing agents to receive a larger percentage of the commission.
How do bond traders make so much money? ›
There are two ways that investors make money from bonds. The individual investor buys bonds directly, with the aim of holding them until they mature in order to profit from the interest they earn. They may also buy into a bond mutual fund or a bond exchange-traded fund (ETF).
What is the difference between a bond dealer and a bond broker? ›
While a broker facilitates security trades on behalf of investors, a dealer facilitates trades on behalf of itself. The terms “principal” and “dealer” can be used interchangeably. So, when you hear about big financial firms trading in their house accounts, they are acting as dealers.
How do brokers make so much money? ›
How Does a Brokerage Firm Make Money? Generally, brokerages make money by charging various fees and commissions on transactions they facilitate and services they provide. The online broker who offers free stock trades receives fees for other services, plus fees from the exchanges.
For many people, TreasuryDirect is a good option; however, retirement savers and investors who already have brokerage accounts are often better off buying bonds on the secondary market or with exchange-traded funds (ETFs).
What are the disadvantages of TreasuryDirect? ›
Securities purchased through TreasuryDirect cannot be sold in the secondary market before they mature. This lack of liquidity could be a disadvantage for investors who may need to access their investment capital before the securities' maturity.
Do brokers charge a fee to buy T-bills? ›
Buy Treasury bills through a broker or financial advisor
The broker or advisor will typically charge a fee for their services, thereby making it more expensive than buying T-bills directly through TreasuryDirect.
Why do investors sell bonds when interest rates rise? ›
Key Takeaways
Most bonds pay a fixed interest rate that becomes more attractive if interest rates fall, driving up demand and the price of the bond. Conversely, if interest rates rise, investors will no longer prefer the lower fixed interest rate paid by a bond, resulting in a decline in its price.
Why do investors sell bonds before maturity? ›
However, by selling bonds after they have risen in price – and before maturity – investors can realize price appreciation, also known as capital appreciation, on bonds. Capturing the capital appreciation on bonds increases their total return, which is the combination of income and capital appreciation.
Why are investors selling bonds? ›
Investors of bonds, however, may decide it is more advantageous to sell a bond rather than hold it to maturity. Some of these reasons include anticipation of higher interest rates, that the issuer's credit will be lowered, or if the market price seems unreasonably high.
How do independent broker-dealers make money? ›
How Do Independent Broker-Dealers (IBDs) Make Money? IBDs generate revenue through transaction-based commissions, fees for assets under management, service charges to advisors, and revenue sharing from product sponsors.
Do broker-dealers charge commission? ›
Generally speaking, broker-dealers are persons that act as securities dealers or brokers or perform both functions. A broker is an individual or firm who acts as an intermediary between a buyer and seller, usually charging a commission.
What happens when a broker-dealer fails? ›
Overview. Typically, when a brokerage firm fails, the Securities Investor Protection Corporation (SIPC) arranges the transfer of the failed brokerage's accounts to a different securities brokerage firm. If the SIPC is unable to arrange the accounts' transfer, the failed firm is liquidated.
How do brokers get commission? ›
When a broker puts a borrower in touch with a bank, and the borrower's mortgage application is approved, the bank will pay the broker a commission. For as long as a borrower keeps their mortgage with a bank, the broker that arranged the loan will keep receiving a smaller ongoing commission, known as “trail” commission.
