What Is a No-Fee ETF?
A no-fee ETF, or zero-fee ETF, is anexchange-traded fund (ETF)that can be bought and traded without paying a commission or fee to a broker. An increasing number of brokerages have been offering investors the chance to buy or sell these securities for free in order to remain competitive with other platforms.
Key Takeaways
- A no-fee ETF, also known as a zero-fee ETF, is anexchange-traded fund (ETF)that can be bought and traded without paying a fee to a broker.
- Brokerages generally offer free trades to draw investors to their platforms and remain competitive — normally there's a charge each time an ETF is bought or sold.
- Sometimes ETFs are traded several times per day, so their no-fee counterparts can save investors a lot of money.
- However, free trading might result in fewer choices, as well as encouraging investors to trade more often and face steeper tax bills.
Understanding a No-Fee ETF
A no-fee ETF is generally usedto attract potentialinvestors to move their accounts to a new broker. Brokers offer to complete these trades for free in the hope of attracting new clients, who will also conduct more profitable trades with the same broker. No-fee ETFs can also make money by lending stock or offering lower interest on cash funds.
Exchange-traded funds aim to replicate the performance of a broad equity market or specific sector and can be traded on exchanges throughout the day just like an ordinary stock. Normally, a charge is levied each time an ETF is bought or sold. There may also be an annual fee to pay for the fund's administrative costs, paid out from the fund's assets or from stock dividends. Frequent traders or day traders may rack up substantial expenses that can quickly eat into any profits.
History of No-Fee ETFs
ETFs were first marketed as a low-cost alternative to mutual funds, where professional money managers choose a basket of securities in which to invest. Since it is rare for a fund manager to consistently beat the market, ETFs offer the advantage of tracking the market without the additional cost of employing specialized stock pickers.
The rate of commission charged for ETF trades can vary greatly between brokers, based upon what type of additional services they provide. Brokers that just conduct trades are likely to charge a lot less than brokers who provide additional advising or management services.
Important:
A trading fee can range anywhere from as low as $5 per trade to upwards of a few hundred dollars per trade, depending on the type of service offered by brokers.
During the 2010s, brokers and fund providers competed to attract new customers by cutting fees and commissions, ultimately resulting in an arms race towards zero costs. Charles Schwab, E*Trade, TD Ameritrade, and Fidelity each offered their own products with minimal or zero fees.
While these products did not earn a direct profit for the brokerage, intense competition and consumer demand left them little choice.Scottrade, an online brokerage with three million clients, was heavily criticized for the lack of commission-free ETFs, resulting in its closure in 2016.
A lack of no-fee ETF trades are considered to have contributed tothe end of Scottrade.
Criticism of No-Fee ETFs
No-fee ETFs have been applauded for helping investors to save money, but they also come with several drawbacks. Since these funds cannot charge fees and commissions, they must pay their administrative costs through other means, such as lending assets, selling other products, or cutting back on other client benefits.
One of the main scruples is a lack of choice. Index-tracking funds are comparatively inexpensive, but that limits investors to products that track broad market trends. Some no-fee ETF deals may be struck as part of a marketing arrangement with a particular asset manager, leaving investors with a limited range of funds in which to invest.
There have also been complaints that no-fee ETFs encourage investors to trade too much. Some behavioral analysts believe that eliminating commissions encourages frequent trading. Numerous studies show that this isn’t a good thing, as the more investors trade, the worse they tend to perform. Frequent trading also leads to higher tax bills because sales on positions held less than a year are taxed as ordinary income.
Special Considerations
Investors shouldn’t fall into the trap of believing that a no-fee ETF completely frees them from paying any kind of trading commission. In some cases, hidden costs can still crop up in the trading spread, or bid/ask ratio—a two-way price quotation that indicates the best potential price at which a security can be sold and bought at a given point in time. High spreads are particularly common among less liquid, sporadically traded ETFs.
