Best Of 2016: Do Commission Free ETFs Sway Decisions?

December 01, 2016

[Editor's Note: We are rerunning some of our best stories of 2016.]

There’s a growing number of ETFs being offered commission-free across various platforms. But when it comes to picking the right ETF for a client, are advisors swayed by the appeal of commission-free ETFs? In other words, is that a key driver in advisor choice of one ETF over another in a given segment?

The answer, put simply, is that it depends—and it depends primarily on the size of the advisory and the size of the account.

Michael Kitces, financial advisor and the author of the “Nerd's Eye View” blog, says that for most advisors who manage “fairly sizable ETF portfolios,” having a fund be offered commission-free “rarely” sways their ETF pick.

Expense Ratios More Important

“For most of the ‘commoditized’ big-index solutions, advisors gravitate to the ones that clearly have lowest cost, e.g., Vanguard, BlackRock, and just let the transaction costs be paid,” Kitces said.

According to him, in most cases, fees of about $9.95 or less per trade isn’t all that material for accounts that are big, as in those with hundreds of thousands, or millions of dollars in assets.

In those cases, the cost of trading is “typically made up by just picking the lowest-expense-ratio ETF over any reasonable holding period,” he said.

“If the advisor wants to buy a more ‘specialized’ ETF, they’ll buy because of its specialized role, not its lack of transaction costs,” added Kitces.

Other Factors Matter More

Kitces’ view is hardly unique. Kevin Grogan, director of investment strategy at BAM Advisors—a member of the BAM Alliance comprising some 140 independent wealth management firms—also says account size plays a role here, and that other factors trump trading fees when it comes to picking the right ETF for a client.

“For our clients, whether or not an ETF has a transaction fee tends not to be a huge factor in which ETF is selected for a portfolio,” Grogan said. “The reason for this is that we don’t trade all that much, so the transaction fee isn’t incurred very often. When we do trade, it tends to be in sizes that are large enough that the transaction fee is small in percentage terms—normally 1 basis point or less.”

So when does commission-free matter? As Grogan put it: “When we need to park cash for a period of time before we accumulate enough cash to buy [a security], we’ll use a no-transaction fee short-term bond ETF for a period of time.”

No-Commission Matters For Smaller Accounts

It also matters for advisors working with a smaller portfolio or a smaller account, where trading fees can represent a significant cost.

“The one scenario where I do commonly see advisors ‘swayed’ by no-transaction-cost ETFs is when the advisor either works with much smaller clients/accounts, where even $9.95 trades are a material transaction cost,” Kitces said.

“That could be an advisor who specializes in smaller clients, or in cases where the advisor has a ‘small accounts’ portfolio model,” he noted.

 

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