The recent news from Charles Schwab, TD Ameritrade, and E-Trade that they will be reducing commissions on Exchange Traded Funds (ETFs) and Stocks to $0 is huge news. The road to $0 commissions (transaction fees) has been a long time coming. From the birth and proliferation of the discount broker in the 90s, transaction costs have been shrinking.
We at FSG are thrilled with this development. For years we have believed that ETF(s) are a fantastic tool for investors. When we partnered with TD Ameritrade in 2017, we significantly expanded our use of ETF(s) due in part to the ability to use hundreds of ETF(s) with zero transaction fees and hundreds more for a minimal cost. The benefit of being able to trade, rebalance, invest more, or take income from an account without having to worry about transaction fees or hidden account fees has a huge impact over time. This benefit, along with other perceived structural advantages ETF(s) have, is a big reason why FSG uses them alongside Mutual Funds.
At this point, you might be asking yourself what an ETF is? Which means I have gotten ahead of myself with this writing. To put it simply, an ETF is a financial instrument that works very similarly to a mutual fund. ETF(s) own investments such as stocks and bonds just like mutual funds; however, there are major differences in how ETFs function, which helps lower costs and adds transparency for investors.
With traditional mutual fund investors, buy and sell (redeem) shares of the fund from the mutual fund company. This is typically an overnight cycle and it means that the mutual fund must hold onto enough cash to pay investors that might wish to sell. That cash could otherwise be invested. An ETF, on the other hand, is bought and sold from other investors or from market makers who are authorized to create shares on behalf of the ETF distributor. When ETFs are bought and sold on the open market, the transaction is often executed in fractions of a second and at a lower cost than mutual funds. The process by which ETFs are traded also means that the mutual fund company is not involved therefore removing a layer of cost. Even before the recent announcements by TD Ameritrade and others, it was common to buy or sell an ETF for $4.95 a trade compared to $20 for an institutional mutual fund.
In addition to how ETFs trade, how they invest also differs from mutual funds. A traditional mutual fund could be active (trying to beat a stated index), passive (look similar to an index), or it could be an index fund simply trying to clone an index. Active funds in particular charge a premium for their management abilities. Most industry statistics have shown it is very difficult for these funds to beat their index after fees. This is where ETFs come in. ETFs by and large track an index at a very low cost. This means that you can essentially buy an ETF for no transaction fee that will track an index at a cost that is the same or lower than a comparable mutual fund which will charge a transaction fee.
Due to the reasons I have highlighted, and a handful of other more technical reasons, ETF(s) have grown in popularity drastically. According to ETF.com this July U.S. ETF(s) had more than $4 trillion invested in them. That is pretty dramatic for an instrument that only debuted in the U.S. in 1993! For those that are interested in the story of the first U.S. listed ETF, here is a good read: https://www.linkedin.com/pulse/story-behind-spy-very-first-us-listed-etf-jim-ross-1/. In summary, State Street Global Advisors released the first U.S. ETF in 1993, which launched their household brand of "SPDR" ETF(s). Interestingly enough, the first U.S. ETF is still the largest in the world.
Like any other financial product, ETFs are a tool. If used correctly, they can provide low cost, transparent, and efficient access to capital markets. Mutual funds are still a fantastic tool that we implement, and when we believe it benefits our clients we use both mutual funds and ETF(s) to create diversified portfolios. Of course, both of these products invest in markets which has risk, which is why you should ensure you understand the risk of investing. As always, FSG strives to ensure you are comfortable with the risk in your portfolio, and we will continue to be relentless in providing the best service and tools for your benefit!
This commentary on this website reflects the personal opinions, viewpoints and analyses of the Financial Strategies Group, Inc employees providing such comments, and should not be regarded as a description of advisory services provided by Financial Strategies Group, Inc or performance returns of any Financial Strategies Group, Inc Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Financial Strategies Group, Inc manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
This article is written by Brice Carter.