Another Step Toward Fee-Free ETFs

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Price wars often continue until one competitor sets prices so low that there's no way anyone else can undercut it. That trend seems to be exactly what's happening with commission-free exchange-traded funds, and it's a big potential positive for investors.

Tomorrow, Scottrade is set to announce that it will join a large group of other brokers by offering a line of commission-free ETFs to its customers. Although the discount broker missed an opportunity by passing up a prospective partnership with the sole remaining uncommitted major ETF manager, Scottrade did advance the ball against its rivals on the most important factor for many investors: lower fees.

Keeping score
For nearly a year and a half, the discount brokerage industry has gone through major changes with ETFs. To bring you quickly up to speed:

  • Schwab (NYSE: SCHW  ) fired the first volley by introducing its own line of proprietary ETFs. Since their introduction, Schwab has cut fees to match or beat its lowest-cost competitors.
  • Fidelity answered by announcing a partnership with iShares provider BlackRock (NYSE: BLK  ) to offer 25 popular iShares ETFs at no commission. The broker subsequently added five more ETFs last month.
  • Vanguard then opened its entire universe of self-managed ETFs to its customers at no commission. In many cases, those ETFs were among the lowest-cost alternatives available, although Schwab's undercutting moves beat the fund giant in certain categories.
  • TD AMERITRADE (Nasdaq: AMTD  ) was the first to cross party lines by offering ETFs from multiple providers, including Vanguard, iShares, PowerShares, and State Street's (NYSE: STT  ) SPDR line.
  • Most recently, Interactive Brokers (Nasdaq: IBKR  ) announced a line of leveraged ETFs with no commissions.

Scottrade's 15 fund offerings are designed to track indexes provided by Morningstar (Nasdaq: MORN  ) and will cover the various subasset classes of the domestic stock market, with breakdowns by market capitalization as well as sector. Fees will range from a low of 0.05% for broad-market and large-cap ETFs to 0.19% for Scottrade's sector funds. Although the company won't initially have more diversified offerings such as bond or international stock ETFs, Scottrade says that it may add more ETFs after further review.

A missed opportunity?
Scottrade's move to join the ETF price wars is a smart one. With ETFs having gained so much popularity, it's critical not to alienate your client base by leaving them out of the commission-free free-for-all. Moreover, with Scottrade opening up its ETFs not just to individual clients but also to its institutional customers, the broker is ensuring that professional advisors who use Scottrade to hold custody of their clients' assets won't jump ship to rivals like Schwab or Fidelity.

What's not so clear, though, is whether Scottrade's decision to use its own proprietary funds is the best move. The broker will use its recent acquisition of a small ETF company called FocusShares as the vehicle for managing the funds. Although Schwab has shown that a broker can start from scratch and build a respectable asset base in a relatively short period of time, it still takes a lot of work -- and it's unclear whether it can really lure customers from other brokers based on extremely small cost differentials.

With Scottrade committing to its own ETFs, E*TRADE Financial (Nasdaq: ETFC  ) is left as the best-known discount broker without an ETF strategy -- and it still has the potential to execute what I think is the best option left: making an exclusive partnership with State Street to offer SPDRs commission-free. The deal would be beneficial both to E*TRADE and State Street, both of which have struggled against rival leaders to try to regain their status as top players in their respective industries.

Cheers for investors
In the meantime, though, investors have to be pleased to see another shot fired against investing costs. As ETF fees head toward zero, investors increasingly have great options to use simple investments without having their wealth eroded through high fees. In other words, the broker price wars may be hard on the participants, but customers are coming out the clear winners.

Get the commission-free ETFs you want. Pick the right discount broker today.

Fool contributor Dan Caplinger looks forward to the day when brokers pay investors to buy and sell shares. He doesn't own shares of the companies mentioned in this article. BlackRock is a Motley Fool Inside Value pick. Interactive Brokers, Morningstar, and Schwab are Motley Fool Stock Advisor recommendations. The Fool owns shares of Interactive Brokers and Morningstar. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy charges you nothing.

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