Who Will Win This Fierce Fee Fight?

Smart investors make big demands on the brokers they use. Smart brokers respond by giving their customers what they really want.

Over the past three years, brokerage companies have fought among themselves to attract customers by offering deals on the most popular product to hit the financial world in years: exchange-traded funds. Now that the players involved have drawn most of the battle lines, though, one brokerage company is refocusing its efforts and aiming to solidify its status as the lowest-cost provider in the ETF market. That company is Charles Schwab (NYSE: SCHW  ) .

A history of the broker wars
Late in 2009, Schwab made what seemed to be an innocuous announcement: It decided to offer its own line of ETFs. Given that a number of other providers, including Vanguard, State Street's (NYSE: STT  ) SPDRs, and the iShares line of funds from BlackRock (NYSE: BLK  ) , had already ramped up their ETF offerings, Schwab's new ETFs didn't look like anything special.

But Schwab came up with an innovative pitch to its customer base: Buy Schwab's ETFs in a Schwab account and pay no commission. It was an obvious way to build up customer loyalty for products that were starting from scratch, and given how crowded the ETF industry already was, Schwab's move was a masterstroke that gave it a big advantage over other companies trying to attract capital and build funds from the ground up.

Quickly, other brokers followed suit with commission-free ETFs of their own. Fidelity partnered with iShares, while Vanguard offered its own funds. Slowly but surely, most of the rest of the industry, including Scottrade, TD Ameritrade (NYSE: AMTD  ) , and E*TRADE Financial (Nasdaq: ETFC  ) , came up with partnerships or other ETFs on a no-commission basis.

But what about cost?
Yet commissions are only one aspect of the cost equation for ETF investors. You also have to worry about the annual fees that ETFs charge their customers for management and other expenses.

One of the initial attractions of ETFs was how much less costly they were than actively traded mutual funds. Because most ETFs track indexes, the job of ETF managers is far simpler than those that have to pick stocks on their own initiative. Over time, though, ever more specialized ETFs have sometimes charged higher prices as fund managers sought to maximize revenue amid intense competition for assets under management.

However, at the other end of the cost spectrum, Schwab, Vanguard, and Scottrade's FocusShares have fought a battle for the ETFs with the cheapest fees. In its latest salvo, Schwab has made some huge moves to make ETF investing cheaper.

In particular, here's what Schwab has done:

  • Cut its bradest-market U.S. stck funds' expense ratis t 0.04%.
  • Slashed large-cap and mid-cap fferings nearly in half t 0.07%.
  • Dramatically drpped expense ratis n internatinal ETFs, including emerging markets.
  • Cut its bradest bnd ETFs' fees in half.

As a result of the move, many of Schwab's fees now undercut Vanguard substantially, despite Vanguard's reputation as a low-cost provider. With FocusShares ETFs having shut their doors after failing to attract enough assets to make them economically viable, the spotlight will be on Vanguard to see whether, or how, it responds to Schwab's moves.

Diminishing returns
As important as low costs are, it's important to keep some perspective here. Schwab's cuts on its broad-market ETF amounted to two hundredths of a percentage point, or $2 annually on a $10,000 investment. I like having $2 better than not having $2, but for many investors of modest means, ETF costs have gotten so low that the differences are minuscule.

Still, if you're looking for ways to simplify your investing, commission-free ETFs can be a valuable tool in your investment arsenal. The right broker can jump-start your saving and get you on your way to your financial goals.

Get the basics on commission-free ETFs from this article in our Invest Better series and learn everything you need to know about brokers from the Fool's Broker Center.

Fool contributor Dan Caplinger is happy with his commission-free ETFs. You can follow him on Twitter @DanCaplinger. He doesn't own shares of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Schwab, BlackRock, and TD Ameritrade, as well as writing puts on TD Ameritrade. 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 is as cheap as we can make it.


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