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Should ETF Investors Change Brokers?

Should ETF Investors Change Brokers?
Ron DeLegge
October 5, 2010

SAN DIEGO ( Ė If you own exchange-traded funds (ETFs) inside a brokerage account, Wall Street wants you as a customer. Why? Because ETF assets and trading volume account for a growing and significant portion of all stock market activity. Naturally, brokers want to capture that business.  

Over the past several months, major brokerage firms like Charles Schwab, Fidelity and Vanguard have made aggressive offers to lure ETF investors into their fold. 

Should you bite?

The Pitch
ETFs are low cost mutual funds that trade like stocks. And as with individual stocks, every time you buy or sell an ETF a brokerage commission will probably apply.

But like many other industries, the cost of online ETF trades has become completely commoditized and cutthroat. A brokerage firm that offers $7 online trades is quickly undercut by another firm that offers the same service for less.

Charles Schwab allows commission free trading to its brokerage clients for Schwab ETFs. The zero cost trading doesnít apply to other ETF families, but with Schwabís expanding ETF menu, the offer is quite compelling. At the end of July, the San Francisco, CA-based investment firm had around $1.42 billion in ETF assets.

In May, the Vanguard Group moved to offer commission free ETF trades for 46 of its Vanguard ETFs. The program allows Vanguardís brokerage clients to buy and sell Vanguard ETFs without paying any brokerage commissions.

Vanguardís brokerage clients typically pay $2 or $7 to trade individual stocks and non-Vanguard ETFs. The actual trading commission paid depends on the size of a clientís brokerage account. Investors with accounts $1 million or more are allowed 25 commission free trades per calendar year on stocks and non-Vanguard ETFs.

Along similar lines, Fidelity Investments teamed up with BlackRock to offer commission free trades on 25 iShares ETFs.

Opening up New Doors
For ETF investors commission free trades are a bonanza. This is especially true for people with retirement plans like traditional IRA, ROTH IRA or self-directed 401(k) plans where money is invested for long time periods. Minimal or nonexistent ETF brokerage costs combined with lower annual expenses compared to mutual funds provide a significant advantage to the ETF investor.

Commission free ETF trades also open the door for other opportunities. 

Strategies like dollar cost averaging using ETFs now become a viable option. Also, the cost of periodically rebalancing your ETF portfolio is greatly minimized. The argument that dollar cost averaging only works with mutual funds and not with ETFs is now rendered completely invalid.

Commission free ETF trading could force other brokerage firms and ETF providers to team up or to risk losing ground to organizations that offer it. On the other hand, if commission free ETF trades donít deliver bottom line results for the companies offering it, donít be surprised to see it go away. 

Great as it may be, commission free trades do have their drawbacks. The menu of ETFs that qualify for zero cost trades is usually limited. For instance, if you want to buy a specialized fund that focuses on gold (NYSEArca: GLD) or a specific country like Brazil (NYSEArca: EWZ) or uses leverage (NYSEArca: SDS), the free trade offer probably wonít apply.

The other disadvantage of commission free trades are behavioral.

Churning in and out of ETFs, or anything for that matter, is usually hazardous to your financial well-being. Itís often more productive to hold onto a good investment than to buy and sell it twenty times on the same day.

But overall, the benefits of commission free trading probably outweigh the negatives. 

This is especially true for active investors with lots of trading activity where the cost savings of commission free trades could be significant. Do the math. Evaluate the entire spectrum of facts and decide for yourself. Who knows? It may be time to change brokers. 

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