How to Win With Fidelity's Free iShares ETFs

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Vicious competition among well-known discount brokers may not be good news for the brokerage industry, but it's almost definitely great news for investors. Several of the largest brokerage companies now give their investors commission-free access to ETF trading.

Yesterday, we took a look at how Vanguard was the most recent entrant in the broker price wars, opening its lineup of exchange-traded funds to accountholders. Vanguard's move was largely forced by the action of mutual-fund archrival Fidelity, which had teamed up with BlackRock (NYSE: BLK  ) and its iShares offerings.

Building a partnership
When Charles Schwab fired the first bullet with its overall commission cuts, it used the occasion to roll out a set of homegrown ETFs. With a higher commission structure, Fidelity had to respond to Schwab's move, but it didn't have its own set of ETF offerings. Rather than going the same route as Schwab and Vanguard -- by offering in-house funds -- Fidelity decided to make a partnership deal with ETF provider iShares.

The arrangement brings the advantages of commission-free ETF trading to Fidelity customers, making it practical for those who set aside small amounts regularly from their paychecks to make regular investments without having commissions eat up a huge portion of the investment.

Is the biggest the best?
Perhaps the biggest advantage for Fidelity is that iShares funds are already household names within the ETF industry. iShares leads the world in ETF issuance, and the iShares fund covering a particular market index or sector is often the biggest, with corresponding benefits such as greater liquidity.

The downside is that many iShares ETFs aren't included in the arrangement. Fidelity accountholders have access to just 25 of the more than 400 iShares ETFs. Fortunately, that's enough to build a complete portfolio. Here are five funds that will get you there.

1. iShares S&P 500 Index (NYSE: IVV  )
The S&P 500 is the quintessential large-cap market index. While the SPDR Trust is better-known, the iShares S&P ETF runs a strong second, with $22.5 billion under management. With a puny 0.09% expense ratio, you won't pay a lot for your shares over time.

2. iShares Russell 2000 Index (NYSE: IWM  )
To fill in the gaps, adding small-cap stocks makes sense for diversification purposes. iShares' small-cap ETF tracks the well-known Russell 2000 index. At 0.24%, its expense ratio shows the added costs of small-cap investing, but the fund's $16.9 billion size is no small thing.

3. iShares MSCI EAFE Index (NYSE: EFA  )
One of iShares' strengths is in international ETFs. This benchmark investment tracks the MSCI EAFE index, which follows the performance of developed-country markets around the world. With nearly 900 holdings and $32.4 billion in assets, the fund offers investors broad-based international exposure. Those who want emerging-market stocks, however, will have to look to the iShares MSCI Emerging Markets Index (NYSE: EEM  ) , as the MSCI EAFE index doesn't include emerging countries.

4. iShares Barclays TIPS Bond (NYSE: TIP  )
This ETF gives shareholders exposure to the bond market, but it isn't the typical type of bond. Regular bonds are subject to inflation risk; if inflation rises, then the value of existing bonds typically falls. But the bonds that this ETF owns are inflation-indexed, meaning that their principal value rises with increases in the consumer price index. TIPS shouldn't necessarily be the only bonds in your portfolio, but if you think inflation is a risk, you'll definitely want part of your money there.

5. iShares S&P National AMT-Free Municipal Bond (NYSE: MUB  )
With Barclays having taken over bond-related assets from Lehman Brothers, bonds are another of iShares' strengths. This ETF has a broad set of holdings from throughout the universe of municipal bonds, which pay interest that's tax-free to investors. For high-bracket taxpayers, munis can give you better after-tax returns than traditional bonds. If munis aren't your style, though, you'll find several other bond funds, including corporate bonds via the iBoxx Investment Grade Corporate ETF (LQD) and the JPMorgan USD Emerging Markets ETF (EMB).

Fidelity definitely doesn't need to feel threatened by Vanguard's recent salvo in the broker wars. Although iShares funds are sometimes more expensive than similar Vanguard ETFs, the differences are minor. More importantly, with a commanding lead in many market segments, iShares ETFs have the panache of an industry leader. Whether you have a Fidelity account or are considering opening one, you can definitely put together a strong portfolio using these fee-free ETFs.

Stay tuned as Dan continues his look at broker offerings of exchange-traded funds. Tomorrow: a look at the broker that started the free-ETF revolution, Charles Schwab.

To find the best broker for your money, be sure to check out the Fool's Discount Broker Center.

Fool contributor Dan Caplinger doesn't think his suggested ad slogan of "iShare, you share, we all share with iShares" is going to catch on. He and the Fool own shares of iShares Barclays TIPS Bond. Charles Schwab is a Motley Fool Stock Advisor recommendation. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy shares information with you.

Read/Post Comments (2) | Recommend This Article (11)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 19, 2010, at 11:50 AM, jmt587 wrote:

    Just switched this week from mutual funds to Fidelity's commission free ETF's with most of my retirement money. The one place I thought they had a gap was non-US Americas International funds, so I added some ILF and EWC. I'm really excited about the new offerings.

  • Report this Comment On May 21, 2010, at 1:03 AM, milekul wrote:

    Charles and vanguard offer free for their own issued etf. so they can earn from mgt fee.

    How does fidelity earn money if it is free? is there a catch?

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