Firstrade Makes a Splash With 700 Commission-Free ETFs (Including Vanguard!)

Firstrade Securities was one of the earliest online discount brokers, but it's far from a household name because it caters to a small niche as the go-to U.S.-based broker for Chinese-speaking traders. But that could soon change.

The discount broker now has its sights set on a larger demographic of investors who use exchange-traded funds (ETFs) to invest. Firstrade rolled out commission-free trades on more than 700 ETFs, including some popular ETFs from issuers like Vanguard, which are hard to find in fee-free form after they were culled from TD Ameritrade's (AMTD) list of commission-free ETFs last year.

The move makes Firstrade the broker with the most commission-free ETFs by a long shot, more than doubling TD Ameritrade's assortment of 300 such funds.

What's included in Firstrade's 700 commission-free ETFs?

There are roughly 2,000 exchange-traded funds in existence, but most aren't necessarily designed for the long-term retirement investor. Firstrade narrowed its list to about 700 funds, or roughly one-third of all ETFs on the market today.

Firstrade's commission-free choices include 40 of the 50 largest ETFs by assets, based on my review of its fund lineup. And of the funds it doesn't offer (such as the largest ETF, SPDR S&P 500 ETF) there are often workable replacements (iShares' and Vanguard's S&P 500 ETFs) that offer the exact same exposure at a lower expense ratio. 

The table below shows indexes and asset classes that are especially popular for hands-off retirement investors, and the commission-free ETFs that track them.

Data source: Firstrade, data compiled by author.

Firstrade's commission-free ETF list stands out for being clearly designed with the long-term investor in mind. It features low-cost, plain-vanilla ETFs that people are most likely to buy and hold for the long haul in an individual retirement account (IRA), and it purposefully excludes any leveraged ETFs that are most likely to cause trouble for investors.

And while all ETFs are technically commission-free if you use a zero-commission brokerage such as Robinhood, Firstrade offers the ability to open a tax-advantaged IRA, whereas Robinhood only offers taxable accounts for now.

An investor could conceivably open an account at Firstrade, buy a diversified portfolio of low-fee index ETFs, and pay nothing in commissions and almost nothing in fund fees to make it all happen. The only catch is that commission-free ETFs have to be held for 30 days before they can be sold, otherwise its clients will pay $2.95 for the trade (its standard commission) as a short-term trading fee.

Competing for customers

In a competitive brokerage world, every broker is looking for an edge, and investors looking for commission-free ETFs have recently paid the price for it.

It wasn't all that long ago that TD Ameritrade was viewed as the broker for commission-free ETFs. In the past, the discount broker outsourced fund selection to Morningstar, which picked ETFs for TD Ameritrade's commission-free list based on their own third-party analysis. TD Ameritrade had a lot of popular (and good!) ETFs its clients could trade for free, but the brokerage was leaving a lot of money on the table because of it. In a controversial move, TD Ameritrade reworked its list of commission-free funds last year, eliminating many investors' favorites.

Image source: Getty Images.

It may not be obvious, but commission-free trades are more than just a marketing tool for discount brokers; they're also a way to make money. Charles Schwab (SCHW 1.01%) charges asset managers a fee to make their ETFs and mutual funds commission free, collecting about $0.19 in annual fees for every $100 its clients invest in other companies' ETFs and mutual funds. Last year, Schwab generated more income ($957 million) from offering such funds to its clients than it earned in commissions ($600 million) on trades its clients actually paid for!

Most brokers monetize their commission-free ETF list this way, which is why finding a simple, cheap index fund can be like finding a diamond in the rough. Ordinary index ETFs favored by long-term investors generally don't need the marketing help, and don't charge fees high enough to pass on a big cut to the brokers, so they are only rarely offered as free to trade.

Firstrade seems to be taking the view that commission-free ETFs can be used as a marketing lever rather than a direct profit driver. It's notable that Vanguard, which has a long-held policy not to pay brokers for distribution, isn't ignored in its list of commission-free ETFs. That suggests to me that Firstrade isn't picking ETFs based solely on how much they'll pay to be included.

Targeting the retirement investor

It's a simple reality that brokers prefer active traders to inactive investors. People who trade more frequently pay more in commissions, so a brokerage firm would prefer to have a day trader than a once-a-year retirement investor, all else equal.

That said, as interest rates rise, acting as the home for inactive retirement investors can be lucrative, since brokers can earn interest on the cash their clients hold in their accounts. Of course, free perks also bring in customers who will pay for the occasional stock and options trade, too.

Firstrade's commission-free list solves a clear market need. By offering so many commission-free ETFs, its clients can build a diversified portfolio of commission-free funds with low on-going management fees. That's not always easy to do, and believe me, I've tried. (See some of my articles on the best commission-free ETFs at Charles Schwab, TD Ameritrade, and Fidelity. Many commission-free ETFs have overlapping holdings with one another, so it's difficult to build a diversified portfolio with commission-free ETFs alone.)

As competitors turn to fund freebies as a way to generate revenue, Firstrade is carving out a new niche as a brokerage firm for the cost-conscious fund investor.