What is a Commission House?
The term commission house refers to a service provider that buys and sells different types of assets. These firms are normally full-service brokerage firms, which means that the fees and commissions they charge their clients are generally steep and may often be deemed unnecessary. As such, these fees may take away a big chunk of an investor's principal balance. These companies commonly use omnibus accounts to handle transactions for multiple clients.
- A commission house provides services for buying and selling all kinds of assets, including stocks, mutual funds, and bonds.
- These full-service firms charge their clients very high fees and commissions.
- Firms get paid for executing orders, arranging settlements, or servicing margin accounts on behalf of their clients.
- These transactions are generally executed through omnibus accounts, which are held for multiple clients.
- High fees charged by commission houses are commonly seen through annuities and load mutual funds.
How Commission Houses Work
Commission houses are full-service brokerage firms that offer a range of services to their clients. Some of the services commission houses provide include buy and sell transactions for different securities, such as bonds, stocks, or commodities.
These firms get paid for executing orders, arranging settlements, or servicing margin accounts on behalf of their clients. Unlike self-directed brokerages that allow their customers to place trades on their own and pay nominal fees, full-service providers like commission houses often charge heavy fees and commissions.
They typically use omnibus accounts to do this. These accounts permit trades to be managed for two or more people. As such, transactions are carried out in the broker's name rather than the investors'. Commissions and other fees, though, are charged directly to the investors. Trade confirmations and account statements are also sent to each investor whose trades take place through an omnibus account.
Commission houses are generally geared to those with high-net-worths rather than average investors because of the range of fees they charge.
The fees charged by commission houses can eat into an investor's principal. For example, two mutual funds with nearly identical holdings may charge varying expense ratios—one with 0.6% offered by a traditional brokerage firm and the other with 1.6% through a commission house. This means a $10,000 investment in the lower fee fund grows 10% over 20 years for a total of $60,300. The same investment in the more expensive fund through the commission house will only grow $50,200 if we use the same time period and interest rate.
This is even more noticeable when it comes to load-mutual funds and annuities—two products that already come with high fees. Adding commissions of up to 10% on the principal amount means investors wind up paying a big chunk to a commission house.
Annuities are financial contracts that are designed to provide individuals with a stream of income during retirement. These contracts include a mortality and expense charge, fund management fees, and costs to ensure your principal balance. The annual cost for a variable annuity can range anywhere between 1% and 3%. Some annuities come with what is known as a back-end surrender charge. This means if you cash out the annuity, you pay an exit fee typically during the first seven years of ownership.
Load Mutual Funds
Load mutual funds are those that come with commissions or sales charges that pay the intermediary, which is the commission house, rather than the fund company. These funds come in three different variations:
- An investor pays a transaction fee upfront at the time of purchase for an A-load fund. For example, if you invest $10,000 in one with a 5% front-end load, $500 goes to pay the commission leaving $9,500 to be invested.
- A B-load fund, on the other hand, penalizes you if you sell it within a certain period. A 6% back-end load may be required if you sell in the first year and decreases a percentage each year until it reaches zero.
- C-funds impose neither a back- nor front-end load. Instead, they add a sales charge into the expense ratio that is much higher than most no-load funds.
Examples of Commission House Trades
Here's a hypothetical example to show how commission houses work. Let's assume an investor wants to buy a U.S. growth stock mutual fund. They have the option of buying an A-, B-, or C-fund. Because the investor holds the investment for more than 10 years, they decide to go with the B-fund because of the longer time horizon. Since the investment amount is fairly small, they won't receive a breakpoint with the B-fund. After a long period of time, like 6 years, the B-fund converts to an A-fund.
Another example would be if an investor has a large amount of money to invest in the above scenario. Because they have $250,000 to invest, they end up going with an A-fund because of the break they get on load fees. The investor has a long-term investment horizon, with the intent of holding the investment for more than 10 years.