What Commission-Free Trading Means to Investors

Editor's Note: Paul Weisbruch is the VP of ETF/Index Sales and Trading at Street One Financial, an ETF liquidity provider focused on quality trade execution as well as portfolio construction and product strategy in the ETF space.


With all the media attention focused on brokers offering "commission-free" trading in specific ETFs, I decided to take a look at what "commission-free" means to institutional and individual investors.

Charles Schwab (SCHW) ETFs started this trend in late 2009 when it ventured into the ETF-issuer business itself, offering commission-free trades to Schwab brokerage customers who traded these products online. These customers can be individual investors or Registered Investment Advisors (RIAs) that use Schwab as their custodian and trade through the Schwab platform. Currently, eight Schwab ETFs can be bought or sold, commission free, on the Schwab online trading platform and these symbols are: SCHF, SCHX, SCHB, SCHA, SCHE, SCHG, SCHV, and SCHC.

Fidelity -- who's also in the online brokerage business and caters to individual investors as well as RIAs that custody at Fidelity -- followed suit in February of this year, and currently offers 26 ETFs to be traded commission-free (25 Blackrock iShares products and one Fidelity ETF, ONEQ). Vanguard was the latest to announce it was joining the "commission-free ETF" arena. Currently it offers free commissioned trades on all 46 of the Vanguard ETFs to its brokerage customers.

Vanguard differs from Fidelity and Schwab as most of the trading customers who use Vanguard's brokerage platform are smaller, individual investors. This difference is significant as for an individual investor trading small amounts of ETFs at a time, commission rates may represent a significant portion of the overall dollar investment and negate the benefits of dollar cost averaging. While the small investor may only choose from a small percentage of the ETF universe when looking for free commissions, it still may be the best economical choice to forgo selection for the lowest possible cost. However, self-directed individuals have different needs and legal responsibilities than RIAs and other Institutional Accounts.

RIAs are charged with managing the overall goals and objectives of their clients and have a fiduciary responsibility to act in the best interest of their customers. They generally earn fees based on the level of assets held by a client. An exodus has been taking place for years, perhaps accelerated by the market events in 2008 which caused many disenchanted financial advisors to "go independent" from the larger wirehouse firms such as Merrill Lynch (BAC), Morgan Stanley Smith Barney (MS)/(C), Wells Fargo (WFC), etc. and create their own practices. These RIAs generally partner with a custodian firm like Fidelity, Schwab, Pershing, or TD Ameritrade (AMTD) for example, for all securities trading, clearing, and related brokerage activities that they previously performed within their wirehouse platforms.

Many of the RIAs I speak with have gone independent, and often their reasons for moving from wirehouses include freedom from “house products.” These advisors were sometimes limited to firm research and were often urged to sell proprietary mutual funds and structured products. This inherent conflict of interest has encouraged a great many financial advisors or brokers to become fee-based RIAs. It's no wonder that advisors and clients alike appreciate the RIA model because of its transparency and lack of visible conflicts of interest. However, the new push for "free commissions on ETFs" risks regression to the old stockbroker model, where a finite list of products are available for sale to clients, and are pushed for dubious reasons.

Today, there are 900 plus ETFs available from 40-plus ETF issuers and the commission-free platforms only offer a small fraction of these ETFs. They're clearly skewed to only four issuers, iShares, Fidelity, Vanguard, and Schwab. As stated earlier, Vanguard isn't a player in the RIA custody business, so the RIAs affected by the "commission-free trades" push are generally those trading with Fidelity and Schwab. TD Ameritrade's Ram Subramaniam was recently cited in the latest edition of Index Universe's ETFR, regarding this topic, and stated that his firm hasn't considered moving to a commission-free ETF model. Instead, TDA believes that offering a robust ETF product spectrum to their RIA clients is of utmost importance as opposed to relegating the choices to a finite list of hand-selected products.

Are some RIAs making their investment decisions based solely on the cost of a trading commission? Judging from conversations with dozens of RIAs, I'd say this does happen. For an RIA to purchase iShares or Schwab ETFs solely for “free commissions” doesn't serve a client who deserves to access the full universe of ETFs, especially if better products that are more suitable for that investor exist. Furthermore, we need to examine how tiny institutional trading commissions are in relation to other factors, like management fees, proper asset allocation and best trade execution. A penny commission on SPY costs the investor .0000935 basis points. That said should SPY be replaced by a “commission-free” ETF for no other reason than the commission rate itself?