Should You Buy Commission-Free ETFs?

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If you're an exchange-traded fund (ETF) investor, or you're thinking of getting started investing in ETFs, you may have seen information on the growing trend of commission-free ETFs.

On the surface, any investment that is free of commissions sounds like a good idea. But free doesn't always mean zero costs. Keeping costs to a minimum is generally smart when it comes to investing, especially when buying and holding mutual funds and ETFs.

However, there are fund expenses in addition to commissions that are associated with investing in funds of all types. Therefore, before you buy commission-free ETFs, make sure you understand how they work and the other fund fees and expenses involved.

How Commission-Free ETFs Work

Commission-free ETFs are exchange-traded funds that do not have any trading costs associated with them. ETFs are similar to mutual funds but they trade on an exchange like stocks, which means that there are commissions associated with buying ETFs. Also called transaction fees, the commissions on ETFs usually range between $10 and $20 at most brokerage firms.

The ETF commission is charged every time you place a trade to buy or sell shares. If you frequently buy shares of ETFs, these commissions can really get expensive over time. But if you can buy ETFs with no commission, you can potentially save hundreds of dollars per year in trading costs, if you buy or sell shares of ETFs at least on a monthly basis.

Companies That Offer Commission-Free ETFs

Almost every brokerage firm and fund company offers commission-free ETFs. Typically, the brokerage firm or fund company has its own proprietary funds, which it offers as commission-free, or it may call them "no transaction fee" or NTF funds. However, the firm will usually charge a commission or fee on sales of ETFs that are not part of its own family of funds.

For example, Vanguard does not charge commissions on its Vanguard ETFs but it will charge a transaction fee on ETFs from a rival such as Fidelity. Therefore, when you are thinking of buying an ETF, it's wise to see if you can find what you are looking for at the brokerage firm or fund company where you have your brokerage account or IRA.

Top Companies That Offer Commission-free ETFs

Broker/Fund Company Commission Commission-Free Funds
Etrade $9.99 80 ETFs from DBX, Global X, and Wisdom Tree
Fidelity $7.95 30 iShares ETFs
Firstrade $6.95 10 ETFs from Vanguard, iShares, and PowerShares
Schwab $8.95 15 Schwab ETFs
TD Ameritrade $9.99 100+ ETFs from iShares, SPDR, and Vanguard
Vanguard $7.00 64 Vanguard ETFs

Data from Forbes

As you can see, most brokerage firms and fund companies offer their own ETFs with no commission fee. However, they typically charge fees for buying shares of ETFs at competing firms. Investors should carefully consider which ETFs work best for their investment objectives and choose the best broker or fund company accordingly.

In some cases, depending upon trading frequency and fund choice, investors should choose which brokerage firm or fund company they use to trade ETFs. For example, if all of their ETF needs can be met with Vanguard, an investor can open an account with Vanguard and buy and sell ETFs there directly.

When to Buy Commission-Free ETFs

Commission-free ETFs are not always a smart trade. For example, if you have an IRA at Schwab and you frequently trade Vanguard ETFs, your trading costs will be too high to justify the buying, holding, and selling of the Vanguard funds. 

However, if you are a purist Vanguard investor and can meet all of your investment objectives by investing exclusively in their mutual funds and ETFs, it makes no sense to buy ETFs from other brokerage firms or fund companies.

It's important to note that ETFs are very much like commodities, meaning that all of the funds that share the same objective or that have the same benchmark will have similar or identical holdings. Therefore, the best ETFs are often the ones that have the lowest expenses.

So, if your brokerage account is at Vanguard and you need an S&P 500 Index ETF, you should buy the commission-free Vanguard S&P 500 ETF (VOO). The holdings will be identical to any other fund that tracks the S&P 500; therefore the one with the lowest expenses is the best ETF to choose for the long-term investor.

When Investors Should Avoid Buying Commission-Free ETFs

Commission-free ETFs don't make sense when the brokerage firm or fund company where you hold your account charges commissions or trading fees. The one exception to this rule is when an investor holds an account at a particular brokerage firm or fund company that has commissions charges for trading ETFs but the investor does not place frequent trades.

Investors should avoid buying ETFs at brokerage firms or fund companies where the trading costs exceed the value of buying and holding the ETF. For example, if an investor has the opportunity of buying and holding an ETF at a certain brokerage company, and the expense ratio of the ETF is the lowest for all funds in its respective category, but the fund company charges $10 per trade, it won't make sense to buy the ETF for an investor who wants to make monthly investments.

For a more specific example, consider a scenario where an investor has an IRA at Schwab but wants to buy shares of a particular category of ETF that is only available at Vanguard or iShares. If the investor wants to buy $100 of the ETF on a monthly basis, the trading costs are $8.95 per month. That's nearly a 9.00 percent expense for buying the fund.

Bottom Line on Commission-Free ETFs

Since most ETFs are passively-managed index funds that track the same respective indices, it makes no sense to buy shares that charge a commission. For example, every mutual fund and ETF that tracks the S&P 500 Index holds the same stocks. Why buy a fund that charges a fee when there are options that are commission-free?

Buying a commission-free ETF leaves you with more cash in your investment instead of going to cover your broker's fees. On the other hand, though, be aware of other costs such as management fees. A brokerage may try to nudge you to invest in their commission-free ETF, but neglect to point out that it has a higher expense ratio and actually costs more than another firm's similar ETF that charges a commission. 

Also, it is important to note other differences with ETFs. For example, ETFs that are new or thinly traded typically have lower levels of liquidity. This means that a small, thinly-traded ETF could have higher trading costs than a larger, widely-traded ETF. You pay these higher trading costs through a wider bid/ask spread when you go to purchase shares of a thinly-traded ETF.

The bottom line is that investors should generally look for ETFs with low expenses and no trading costs (no commissions) whenever possible.

Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.