In a world plagued by high-cost investments and shady financial intermediaries, there is one emerging trend that investors can rejoice in: the mad rush to cut trading commissions on exchange-traded funds. In fact, the moves that major market players are making today are likely to have far-reaching effects on the ETF industry for years to come.
Can’t cut fast enough
Discount broker Charles Schwab (NYSE: SCHW ) started the race to the bottom last year by offering commission-free trades on its proprietary line of ETFs. Fidelity joined the party earlier this year by offering free trades on 25 broad-market iShares ETFs. Now Vanguard has thrown its hat into the ring, offering commission-free trades on its extensive lineup of exchange-traded funds. Odds are good that other large ETF providers, including State Street’s (NYSE: STT ) SSgA line of SPDR funds, will be forced to follow suit in the near future.
As investment firms see their profit margins from traditional ETFs slowly whittled away, this line of business will likely become profitable for only the largest of ETF providers, which are able to reach a critical mass of assets. I’m guessing that actively managed ETFs will become the next big area of growth in this sector as firms look to market new products. I’m still not sold on the necessity or even the long-term viability of actively managed ETFs, so I’d recommend sticking to passively managed exchange-traded funds for now.
How to benefit
There’s no reason you can’t profit right now from the latest move in the ETF commission-cutting game. If you’re one of the many investors who has a Vanguard brokerage account, make sure you’ve got at least one or two of the fund shop’s ETFs in your portfolio.
For all-encompassing market exposure, the Vanguard Total Stock Market ETF (NYSE: VTI ) is a clear winner, with its rock-bottom 0.09% expense ratio and wide market coverage. Investors in search of a specific small-cap allocation should look at Vanguard Small-Cap ETF (NYSE: VB ) , which invests in those small-fry companies that don’t get a big representation in larger market-capitalization-weighted indices.
If you’re looking to fill out the international side of your portfolio, consider the Vanguard FTSE All-World ex-U.S. ETF (NYSE: VEU ) . This fund invests in a wide swath of developed and emerging markets and clocks in with a mere 0.25% price tag. If you want more dedicated emerging-markets exposure, the Vanguard Emerging Markets Stock ETF (NYSE: VWO ) should be your go-to investment. In my opinion, this is one of the best emerging-markets ETFs around, so investors of all stripes should feel confident investing here. Lastly, bond investors should check out Vanguard Total Bond Market ETF (NYSE: BND ) , a one-stop shop for broad fixed-income exposure.
Too much of a good thing?
In general, all of this ETF fee-cutting is a good thing for investors. I always like it when Joe and Jane Investor can get cheaper access to the stock market. Just make sure you don’t use free commissions as a free license to start day trading ETFs. Remember, these are tools for gaining broad, cheap access to wide segments of the market, not vehicles for short-term speculation.
You should still take a long-term approach to ETF investing. So pick the funds you need based on your targeted asset allocation and stay invested for the long run.
Lastly, as a general rule when it comes to ETF investing, remember that simplicity is the key to success. Stick to basic, broad-market funds that offer wide coverage rather than narrowly focused investments that invest in a single country or industry. Those types of ETFs are typically much more expensive and riskier than their broader counterparts.
And whatever you do, stay away from leveraged, and inverse leveraged, funds. Rational investors don’t need to take leveraged bets on the direction of the stock market.
Ultimately, investors should be very happy about the trend of free commissions for so many exchange-traded funds. It makes investing in the stock market much less expensive and is likely to add further pressure to brokerages to continue lowering trading commissions for all types of investments. If you have a brokerage account that allows commission-free trading, make sure you’re taking advantage by owning at least a few solid ETFs.
Check to see if your portfolio is light on any particular asset class, and if so, think about beefing up that exposure with a low-cost ETF. It could be one of the best things you’ve done for your portfolio in a long time.