Chuck Jaffe: Free ETF trades may not be free
There’s a difference between an inexpensive sandwich and a free lunch.
You know exactly what the sandwich costs you, but you have to figure out the real price of “free” when it comes to the lunch.
So when Charles Schwab offered investors a free lunch recently in the form of its “ETF OneSource” platform — which allows investors to buy and sell over 100 ETFs with no online trade commissions — investors were so focused on the “free” that they missed out on the devil hiding in the details.
To be sure, Schwab ETF OneSource is a good thing, another step forward for the ETF business, especially if it leads to more widespread availability of commission-free trades.
It’s not revolutionary. While Schwab compared the new platform to Schwab Mutual Fund OneSource — the supermarket concept it opened more than 20 years ago that allowed investors to do one-stop shopping between fund families with transaction costs reduced or eliminated — it’s not the same kind of game-changer.
Exchange-traded funds, essentially, are mutual funds built to trade like stocks, complete with the commissions on buys and sells. OneSource allows investors to trade ETFs — paying the same underlying operating expense ratio on the fund — without trading costs.
Online brokerages typically charge anywhere from $6.95 to $14.95 per trade. Those dollars add up, especially for investors making regular, small deposits rather than dropping the occasional big chunk of cash.
Several firms offer limited commission-free ETF trading, whether it is Vanguard giving freebies on its house funds or Fidelity going fee-free on 30 different ETFs from iShares, to TD Ameritrade offering no-cost trades on more than 100 different ETFs, including some big name-brand issues.
Schwab ETF OneSource opens with 105 available funds, and while the list includes brand-name providers, it doesn’t necessarily cover the big-time funds.
Beth Flynn, Schwab’s vice president of ETF platform management, noted that the available funds cover 54 different Morningstar-style categories, giving investors commission-free access to the vast majority of the investment world.
The question for average investors is whether that access is good enough.
Want to trade the Standard & Poor’s 500? The SPDR S&P 500 Trust (SPY) — the first ETF and the one with the most trading volume — isn’t on the list; you could settle for the Guggenheim S&P 500 Equal Weight ETF (RSP) or the PowerShares S&P 500 Low Volatility ETF (SPLV), but they’re hardly the same thing.
Likewise, the SPDR S&P MidCap 400 (MDY) is not part of OneSource, but its value-flavored sister is.
Alas, it’s an ugly little sister. The SPDR S&P 400 MidCap Value fund (MDYV) is tiny, with roughly $25 million in assets; its average trading volume is under 2,000 shares per day.
By comparison, the iShares S&P MidCap 400 Value Index (IJJ) is more than 100 times larger ($2.58 billion in assets) and trades over 130,000 shares in an average day, and it is not part of the OneSource platform.
Hint: If you’re looking for the urchin in the fine print, look here.
One key issue that investors often overlook with ETFs is liquidity.
A fund that is lightly traded can have a wide bid/ask spread, the difference in the lowest price a seller is willing to accept and the highest price a buyer was willing to pay as of the last trade.
With a wide spread, it is possible to pay more for an ETF than it is actually worth.
Do that on a large-enough trade and it will wipe out the commission savings; what’s more, the average investor will have a tough time recognizing the point where “free trade” becomes “bad deal.”
There’s also a key difference between the new platform and the original Mutual Fund OneSource.
Two decades ago, when that program was starting, investors could not do one-stop shopping for mutual funds; if you wanted issues from, say, Fidelity and Janus, you needed to deal with the companies directly, and process multiple statements.
For investors — and especially those working through advisers — convenience was as important or more important than the ability to buy some issues without sales loads.
By comparison, you can already buy all ETFs through any broker; the OneSource upgrade, therefore, is the free trade.
Mutual Fund OneSource started with eight fund families and less than 100 mutual funds, and today it has more than 4,000 funds, so the ETF availability issue could evaporate in time.
The same can’t necessarily be said for execution concerns.
Providers are paying up to be involved in OneSource because they want or need the distribution. That explains why a fund like the tiny MDYV is on OneSource, but its thriving big sister isn’t.
If, over time, ETF sponsors raise operating expenses slightly to make up for the dough they fork over to participate, the trades may be free but the cost would be undeniable for all affected shareholders.
Schwab’s 2012 ETF Investor Study released last fall cited cost as the top factor investors consider when selecting ETFs, with nearly 40 percent of respondents saying the ability to trade without fees was either “most important or very important.”
Clearly, Schwab is counting on that sentiment to drive its new platform.
“My concern is that people will get caught up in ‘Ooh, look at what I am saving on the commission,’ and not see that their costs have gone up or that the fund is not exactly the one they wanted,” said Jason Browne, chief investment officer for FundX Investment Group, which uses momentum-driven strategies to trade in and out of both ETFs and traditional funds.
“If this takes off, that could be great for ETF investors, but for right now I think that if you dig past the free trades, you might not be so excited.”
In the end, all things being equal, free trading is the best deal.
The key is to make sure that all things really are equal; if the real cost of your free lunch is more than an inexpensive sandwich, it’s not a bargain.
Chuck Jaffe is senior columnist for MarketWatch. He can be reached at email@example.com or at P.O. Box 70, Cohasset, MA 02025-0070.
Copyright, 2013, MarketWatch