What It Is:
Transaction costs are fees charged by financial companies in the sale and purchase of securities.
How It Works/Example:
When investors purchase or sell securities via a broker or other financial intermediary, the intermediary charges a commission or fee for providing this service. These are costs to the client that generally contain two components: 1) the basic fee charged by the intermediary, and 2) the spread, or differential, between the price paid by the broker for the security and the price at which he is selling it.
To illustrate, suppose Bob purchases 100 shares of XYZ stock from his broker, Jack. He pays $200 for the shares at $2 per share. Jack originally purchased the shares for a total of $180, incurring a $20 spread charged to Bob. In addition, Jack charges a base $20 brokerage commission. Bob pays Jack a total of $220 even though the actual cost of the shares was $180.