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Vanguard Enters the Broker Wars

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When you think of cutthroat competition, the discount brokerage market might not seem like the obvious place to look. But recently, price-cutting among brokers has been fast and furious. Yesterday, a familiar name joined the fray -- and its moves will have an impact not just on competing brokers but also on the entire exchange-traded fund (ETF) industry.

Vanguard announced that effective yesterday, it was cutting its brokerage fees across the board. Depending on the size of your account, you'll pay between $2 and $7 per trade, with million-dollar accounts offering 25 free trades per year. Even the smallest accounts will get the first 25 trades for $7, only then rising to $20.

Weighing in
That $7 figure is no accident. It undercuts the $7.95 commission structure that Fidelity announced back in February. It also beats the $8.95 charged by Charles Schwab (Nasdaq: SCHW  ) .

Long known for its low fees, Vanguard's brokerage services division has been slow to entire the competitive discount brokerage market. For years, the company had above-average trading commissions, perhaps to emphasize its reputation favoring a long-term investment philosophy.

But what likely forced Vanguard's hand was Fidelity's arrangement with Blackrock (NYSE: BLK  ) , the company behind the popular iShares line of ETFs. As part of its recent cost-cutting for customers, Fidelity began offering certain iShares ETFs at no commission.

Vanguard matched that offer, giving brokerage customers free access to trading its own ETFs. In doing so, Vanguard drew the battle lines for what may be the most important fight among major ETF providers.

Armed conflict
Already, Vanguard ETFs are in direct competition with iShares products for supremacy in certain sectors of the ETF market. Although State Street (NYSE: STT  ) and its Global Advisors arm is behind the popular SPDR line of ETFs, Vanguard's ETFs often come with lower fees and have therefore found their own niche among ETF investors.

One area where iShares and Vanguard have come into direct conflict is in the emerging markets realm. With $35.5 billion in assets, the iShares MSCI Emerging Markets ETF (NYSE: EEM  ) is the largest emerging market ETF. But it has a relatively expensive expense ratio of 0.72%. Vanguard Emerging Markets Stock ETF (NYSE: VWO  ) , on the other hand, has only $24.4 billion under management, but its rock-bottom expense ratio of 0.27% gives it a big cost advantage. Moreover, even though both track the same underlying index, Vanguard's ETF has managed to outperform the iShares offering slightly.

Sticking to its principles?
There is one area in which Vanguard is taking a decidedly different tack from other brokers: trading frequency. The new commission schedule includes a provision that says that if you buy and sell a given ETF more than 25 times in 12 months, then you'll be restricted from buying new ETF shares for 60 days. The provision is clearly aimed at extremely frequent traders, since you could still make round-trip buy-sell transactions once every two weeks and still be fine under the guidelines.

Overall, though, the strategy makes sense for Vanguard. It combines the best features of its two competitors' offerings. Like Fidelity, Vanguard is offering free trading of popular, liquid ETFs; but rather than having to go to an outside provider, Vanguard has its own ETFs to make available. And even though Schwab also offers in-house ETFs, they don't have nearly as much in assets as Vanguard, making them less liquid and harder to trade efficiently.

What's next?
It's clear that Vanguard's move will give more exposure to its ETF lineup, which can only help the company in the long run. The open question, though, is what State Street will do to compete with Vanguard and iShares. With Schwab's die already cast, the SPDR purveyor may have to seek an alliance a broker like TD Ameritrade (Nasdaq: AMTD  ) or E*Trade Financial (Nasdaq: ETFC  ) , both of which have thus far stayed out of the free-ETF wars.

For investors, Vanguard's price cuts and free ETFs further expand their ability to invest cheaply. Combined with Vanguard's long-established emphasis on low costs, I think the move is a winner for investors.

Shopping for a broker? Learn more about picking the right one in our Discount Broker Center.

Fool contributor Dan Caplinger always thought the problem with ETFs was commissions for regular investors, so he's psyched about the discount broker price war. He doesn't own shares of the companies mentioned in this article. Charles Schwab is a Motley Fool Stock Advisor recommendation. The Fool owns shares of Vanguard Emerging Market Stock ETF. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy knows how to fight when it has to.


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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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