Should You Worry About Your ETFs Without Commission and Trades?
We’ve all heard that the best in life is free, but when it comes to your investment, is “free” good? Recent changes announced by investment companies may mislead you as to how you should manage your nest.
Last Modified: Charles Schwab announced last month that he would not charge commissions on trading stocks and ETFs. TD Ameritrade quickly announced a similar move.
ETF fees have been approaching zero for a while now, and some firms like Vanguard , Fidelity and Schwab announced free ETFs in the summer of 2018.
Lower cost means greater access to investment funds for consumers who may fear confusing payment structures. But as Bloomberg pointed out this week, there must be a risk for these consumers. Otherwise, these firms would not have had a chance to play out deals.
The race to zero began a long time ago
These no-pay shares have been years in the making, says Adam Grealish, director of investment at roboadvisor improvement . As the popularity of passive investments such as index funds has grown, the investment industry has become more efficient. This is why a firm can do without charging a fraction of a percentage as a rate-of-cost fee when investing in a particular fund.
As individual investors have become smarter over the years, firms have become more competitive. If one large firm cuts rates, others will follow. “This is a healthy competitive dynamic,” Grealish said. So great that we hit the bottom of the barrel of fees.
“The zero-metric war has been going on for 10 years,” says Brent Weiss, CFP and co-founder of Facet Wealth . “Schwab just got ahead of it.”
Schwab had a big advantage that he could take advantage of by being the first to jump into the water without commission. She makes very little money from trade fees – the Wall Street Journal notes that they account for only 7% of the firm’s income. He had nothing to lose from the reduced commissions, while TD Ameritrade earns about 25% of its revenue from trading.
How Investment Firms Make Money Without Trading Commissions
“Nobody runs these companies out of the kindness of the heart,” Grilish said. He outlined several basic ways that firms can compensate for the “loss” of these commissions.
First, there are additional sales. We’ve talked about this before: if the company can invite you to the door with a 10 week offer. Or without commission, she can probably talk you into staying and using a more expensive product later.
Or the firm might make money in other ways that are not related to its individual clients. Grealish said securities lending programs for ETFs are common, allowing the fund to make money by charging the borrower a commission. Or the brokerage company may receive a commission for executing trade orders for third parties.
Another important way that brokerage companies generate income if they don’t charge you a commission: by simply holding on to your money. Some of you pointed this out the last time we discussed a commission-free move. Charles Schwab is known for making a ton of money (we’re talking about half of his income ) by investing unallocated client funds. He pays clients a paltry interest rate on this money, but receives most of the interest from his own investments.
Charles Schwab talks openly about this practice, which brings us to what you need to invest with confidence: transparency.
How to choose an investment firm when they are all “free”
The different ways that brokerage firms make money from your investing activity are not necessarily negative. But you should be aware of their methods and what they might cost you if you sign up for the long term – which is probably exactly what you do if you save for retirement or other extended investment goals.
If you only focus on trading fees, you’re missing out on much of the puzzle: if you’re investing for this long-term growth, you’re probably not going to be making a lot of trades. Therefore, choosing a firm that will only manage your investments based on trading commissions is a shortsighted move.
“Look at your expense ratio, see how the fund is performing against the benchmark,” Grilish said. And while it can be tricky, see what you can learn about other fees you may face and how the firm generates income. Nerdwallet has tons of reviews that you can check out.
Weiss recommends thinking about the question: “How do you make money from my relationship?” as you are considering a firm to manage your investment. “If someone can’t tell you, change the relationship,” he said.