- A trailing commission is the commission a financial advisor gets from the fund house
- The trailing commission often acts as an incentive to the advisor to grow an investor’s investments.
What is a Trailing Commission?
A trailing commission is the commission a financial advisor gets from the fund house every time the former’s clients invest money on one of the latter’s schemes. It can be described as a reward that keeps advisors and clients with a specific fund.
Every time we pay instalments in a Sip financial product, the financial advisor or agent who sold it to us, if at all, gets a trailing commission from the fund house of anywhere between 0.5 and 2 percent of the investment sum (Sip amount).
Of course, the amount gets deducted from our principal kitty as part of TER or as transaction cost.
How much do Trailing Commissions Cost to Investors?
The trailing commission fees vary with the fund. Often it lies in the range of 0.25% to 0.50% of the investment per year. It is not a small amount and generally increases year after year. As your investments grow, the advisor who sold the investment to you will make money through the trailing commission. This often acts as an incentive to the advisor to grow your investments.
How to avoid Trailing Commission?
Trailing commissions are easier to avoid as markets keep growing. There are many exchange-traded funds (ETFs) with cheap costs and many mutual funds without trailing commissions. Even some mutual funds with low costs generate big returns.
Liquid Investments and Trailing Commission
Trailing commission makes sense for illiquid investments like unlisted companies, real estate, and frontier markets. These investments are not there in the US stock market and are likely to have greater returns, but they are more costly to buy and sell. Funds that focus on illiquid investments generally use trailing commission so that their advisors remain loyal and clients invested.
Sebi, in 2018, banned upfront commission which advisors used to earn the first time a client made an investment payment to a fund house through them. Trailing commission is what is left as the primary means of income for the advisory industry.