Zero Fee Trades Likely Means Lower Fee ETFs - Part 1

The investment world was flipped upside-down recently when Charles Schwab eliminated trading commissions on stocks, ETFs, and options last month. The move prompted TD Ameritrade, E*TRADE, and other players in the industry to follow suit quickly or risk losing clients. The move is not the first time we have seen trading commissions reduced, but never before have retail investors been able to trade literally for free.

Most people would claim that the late Jack Bogle started this ‘war on fee’s’ decades ago when he introduced the low-cost index fund at Vanguard. The first low-cost mutual funds offered investors an inexpensive, at the time, option for investors. The low fee option Vanguard introduced proved to be a good move as Vanguard grew its asset base into what is now more than $5.5 trillion. Over the years, other firms began to fight back by cutting their fees, but the war had already started, and investors began to see the value in low-cost options.

Jack Bogle himself would often talk about how fees cost investors hundreds of thousands of dollars over their investing lifetime. The simple idea of paying lower fees equates to higher account balances over time makes perfect sense, especially to anyone who understands the power of compounding returns.

Zero fees on trading commissions will leave millions of dollars in investors' hands. It has been estimated that Charles Schwab alone will lose out on somewhere between $90 and $100 million in quarterly revenue now that they cut their trading fee to zero. That is just $100 million for one firm and one quarter. Based on those figures only of Schwab, we could easily see somewhere close to $1 billion is left in the hands of investors over the course of a year.

Now that we have hit zero fees on trading commissions and investors continue to learn how low-cost investing helps their overall returns, it's likely we will see more fee-cutting throughout the investing industry. The high fee’s on mutual funds have already begun pushing investors to ETFs. And the ETF industry has already started fighting the battle to cut costs.

In 2018 we saw 283 or 13.5% of US-based ETFs have their started cut. Some of the cuts where small, but others were substantial. We have seen the higher costs funds in 2019 experience massive outflows while their lower cost competitors realized large inflows, which is hard to explain why this is happening when all other things are equal, besides the fees. Additionally, investors are looking for the cheapest options available.

On a broad scale, lower fees mean higher returns in the long run due to compounding interest. There is no way around that, and it is becoming clear that the general investing community no longer believes that it's worth paying high fees for the potential of higher returns is good because the data also shows that the vast majority of money managers don’t beat the market over the long run.

The ‘SPIVA U.S. Year-End 2018’ report showed that over the past 15-year period, 91% of large-cap managers, 92% of mid-cap managers, and 96% of small-cap managers didn’t beat their benchmarks. These managers are the ones in charge of the large mutual funds or ETFs known as ‘actively’ traded funds. These are the funds that charge substantially more than the ‘index’ funds that Jack Bogle and Vanguard introduced decades ago the index funds or ‘cheaper’ funds are also typically the benchmarks that money managers are compared.

Reports such as the ‘SPIVA U.S. Year-End 2018’ and many others have essentially proven higher fees don’t mean higher returns. And this has been the case for decades now.

However, while the ‘index’ funds were cheaper, they were still more expensive than they needed to be. Recently that has even begun to change as we have seen fees for S&P 500 index funds come down as low as 0.03% with the Vanguard S&P 500 ETF (VOO). The previous low fee option was the SPDR S&P 500 ETF (SPY), which is at 0.09%. There are several other funds in between the price points, but only recently have we seen fees get below that of what the SPY charges.

Furthermore, since the fees of other S&P 500 index funds fell below that of SPY’s, we have seen massive outflows from what was by far the largest ETF by assets, into those with lower fees.

While none of the big names in the ETF world have yet offered zero-fee ETFs, the move to zero on trading commissions likely means it is just a matter of time until we see it happen.

I’ll explain why in part two.

Matt Thalman Contributor - ETFs
Follow me on Twitter @mthalman5513

Disclosure: This contributor did not own shares of any asset mentioned above at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from for their opinion.