Show pageOld revisionsBacklinksBack to top This page is read only. You can view the source, but not change it. Ask your administrator if you think this is wrong. ======Commission-Based====== A commission-based compensation model is a payment structure where a financial professional, such as a [[stockbroker]] or some financial advisors, earns money by executing transactions on behalf of a client. Instead of charging a flat or hourly rate, the professional takes a fee, or "commission," for each trade they make—whether it's buying or selling [[stocks]], [[bonds]], [[mutual funds]], or other financial products. This commission can be a flat fee per transaction (e.g., $10 per trade), a percentage of the total transaction value (e.g., 1% of a $10,000 stock purchase), or a built-in fee known as a [[load]] for certain mutual funds. This model stands in contrast to [[fee-only]] or [[fee-based]] structures, where an advisor's compensation is tied to the overall value of a client's portfolio or a fixed retainer, rather than the volume of trading activity. ===== The Value Investor's Perspective ===== For a [[value investing]] practitioner, the commission-based model is a field littered with potential landmines. The philosophy of value investing, championed by figures like [[Benjamin Graham]] and [[Warren Buffett]], preaches patience, a long-term horizon, and minimizing costs. The commission-based structure can create a fundamental [[conflict of interest]] that runs counter to all these principles. ==== The Inherent Conflict of Interest ==== The core problem is simple: //an advisor who gets paid per transaction has a financial incentive to encourage more transactions.// This can lead to a destructive practice known as [[churning]], where a broker excessively trades in a client's account primarily to generate commissions for themselves. A value investor, who often aims to buy great companies and hold them for years, if not decades, has little need for frequent trading. An advisor motivated by commissions, however, might be tempted to suggest selling a perfectly good investment to buy another, simply to book a fee. Their "advice" may be colored not by what is best for your long-term wealth, but by what generates the most revenue for them today. ==== The Tyranny of Compounding Costs ==== Warren Buffett famously warned investors about the "tyranny of compounding costs," and commissions are a prime example. While a 1% or 2% commission might seem small on a single trade, these costs act as a persistent drag on your returns. Imagine you invest $50,000. If your advisor frequently repositions your portfolio, you could easily pay thousands in commissions each year. This money comes directly out of your pocket and is no longer working for you. Over decades, the wealth you could have built through [[compounding]] is significantly eroded by these transactional frictions. A value investor knows that every dollar paid in unnecessary fees is a dollar that cannot grow into ten. ===== Pros and Cons for the Investor ===== While the value investing lens reveals serious flaws, it's fair to consider both sides of the coin. ==== Potential Advantages ==== * **Pay-as-you-go:** For an investor who trades very infrequently—perhaps only once or twice a year—a commission-per-trade model might occasionally be cheaper than paying an ongoing annual fee based on [[assets under management]] (AUM). * **Transactional Transparency:** The cost is tied directly to an action. You know exactly what you are paying for each specific trade you make. ==== Significant Disadvantages ==== * **Conflict of Interest:** This is the most critical drawback. The advisor's financial well-being is tied to trading activity, not necessarily your portfolio's performance. * **Incentive for Unsuitable Products:** Advisors may be incentivized to push complex, high-commission products like certain [[annuities]] or non-traded [[REITs]], even if a simple, low-cost [[index fund]] would be more appropriate for the client. * **Erosion of Returns:** As discussed, commissions create a significant headwind that reduces your long-term investment performance. ===== The Bottom Line ===== Understanding how your financial professional gets paid is one of the most important questions you can ask. While the commission-based model isn't inherently evil, it creates a powerful conflict of interest that is fundamentally misaligned with the patient, cost-conscious approach of value investing. For investors focused on building long-term wealth, a fee-only structure, where the advisor's success is directly linked to the growth of your portfolio, typically offers a much safer and more aligned partnership. Always ask the question: //"How do you get paid?"// Your financial future may depend on the answer.