Sunday, February 9, 2014

Best Commission-Free ETFs

Are you a cost-conscious fund investor? Check out our list of the best zero-commission ETFs. The list combines what discount brokers offer in commission-free fund buying with our own take on cost efficiency in portfolio management.

Funds from Vanguard and Schwab dominate the winners' circle, but there are also a few from BlackRock BlackRock (under the iShares name), State Street State Street (SPDR) and Pimco.

The bargain fund list includes the Vanguard Total Total Stock Market Index fund (ticker: VTI) and the Schwab U.S. Aggregate Bond fund (SCHZ). Conspicuously absent is the granddaddy of exchange-traded funds, the SPDR S&P 500 (SPY). It doesn't show up on the commission-free list of any of the four discount brokers we looked at.

Over the past two years there has been an explosion in commission-free fund offerings. The trouble is that a lot of the freebies on trading are attached to funds that are expensive to hold—that is, they have stiff annual portfolio costs. You can quickly lose to a high expense ratio whatever you saved by not paying a commission getting in.

The lists below are limited to funds that are both cheap to trade and cheap to hold. They make up a small subset of the 1,285 exchange-traded funds tracked by the Investment Company Institute.

Each discount broker has its own list of funds available for commission-free investing. The Vanguard Group's brokerage operation gives you a free pass only on funds managed by Vanguard. Charles Schwab Charles Schwab & Co.'s no-commission list has Schwab funds plus a few funds run by other companies. Fidelity Investments has deals on iShares. TD Ameritrade has the broadest mix of fund operators on its zero-commission list.


If you are putting $100,000 into a fund trade, it scarcely matters whether you get $8 off on the commission. But if you are investing $2,000, it matters a lot.

Both big and small investors have to worry about the other costs of investing: the expense ratio and the big/ask spread on the fund's shares. We add up the non-commission expenses to arrive at a ten-year holding cost. This is what you give up over a decade on a hypothetical $10,000 starting investment.

Three components go into the holding cost figure. One is the expense ratio: the annual fee imposed by the operator of a fund. An efficient fund sitting on the stocks of big U.S. companies can get this number down to 0.05%, or $5 a year per $10,000 invested. Expensive funds run up a tab 10 or 20 times as high.

Next comes the offset to costs that the portfolio manager generates by lending securities to short-sellers. For funds that own bonds or the stocks of big U.S. companies, securities lending revenue ranges from modest to nothing. For funds holding foreign and small-company stocks, it can be a big item. At a few funds it's more than enough to cover the expense ratio, meaning that your effective holding cost is negative.

Last item on the cost list is the big/ask spread in the ETF's shares. You forfeit this amount to a middleman when you do a round-trip trade.

Our calculation of the holding cost assumes that your $10,000 stake grows 5% a year. It doesn't allow for the tax you may owe on the way out.

Our expense ratio and bid/ask data come from Morningstar and Bloomberg. The figures for securities lending revenue come from the fund operators. "Commission-free" describes the purchase only, and at some brokers you lose this feature if you sell too quickly (such as within 30 days).



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