Zero-commission exchange-traded funds are certainly alluring for any investor, but there is a limit to the free lunch.
Several Canadian discount brokers market ETFs without trading fees, but investors need to read the fine print. Their offerings have different wrinkles so it pays to do the homework to avoid costly surprises. For instance, some firms have a set menu of zero-fee ETFs, and charge a regular commission for the rest. Other brokers let investors buy any ETF without a fee, but have commission for selling. "At the end of the day, you don't want to be penny wise and dollar foolish," warns John Gabriel, an ETF strategist with U.S.-based Morningstar Inc.
ETFs, which are like mutual funds but trade like stocks, are becoming popular because of their lower annual fees. A drawback has been the commissions required to buy and sell them. That is true for investors who want to make small, regular purchases because the costs add up.
But now there are four online brokers with zero-fee ETF offerings. They include Scotia iTrade, a unit of the Bank of Nova Scotia, Qtrade Investor, Questrade Inc., and Virtual Brokers, a division of BBS Securities Inc. Before climbing aboard, investors need first to think about their investment objective and strategy, and also dig into any other fees beyond those for trading, Mr. Gabriel said.
"Are you an active, tactical investor, or one who thinks long term and likes to invest a lump sum? Or, are you looking to do dollar-cost averaging in smaller amounts at regular intervals? What works for one investor isn't necessarily going to be the optimal platform for another."
The free lineup varies per broker. Scotia iTrade has 50 eligible ETFs, while Qtrade Investors has 60. Questrade allows investors to buy North American-listed ETFs without a fee, but charges a regular commission to sell. Virtual Brokers also does not have a fee to buy North American ETFs, but permits a list of 100 to be sold at no charge.
"A longer-term investor making smaller, frequent purchases may be better off with the all-free option" because fees eat away the returns, Mr. Gabriel said. Keep in mind that Qtrade Investor requires a minimum $1,000-order per trade so that might not be feasible, he noted. Some brokers also charge annual fees to maintain RRSP or other accounts.
Investors need to scrutinize any zero-fee menu closely, or they could end up settling for "a sub-optimal product," he cautioned. "I would not want to be handcuffed to just the list [of freebies]. There are decent offerings, but for the most part, they are very narrowly focused.
"There are a lot of sector and single-country ETFs, and other niche-type products. A socially conscious ETF, the iShares Jantzi Social ETF (XEN), is on all three lists [Scotia iTrade, Qtrade and Virtual Brokers). They also have Latin American, China and a lot of the hot or thematic ETFs that aren't necessarily building blocks for a portfolio."
Still, it may be possible to combine the totally zero-fee ETFs to get a desired exposure, he said. The iShares S&P/TSX Capped Composite ETF (XIC), which is a popular, all-capitalization Canadian equity ETF, is not offered with a totally-free commission. At Scotia iTrade, however, investors could buy the Horizons S&P/TSX 60 ETF (HXT), and the iShares S&P/TSX Completion ETF (XMD) to get similar equity coverage, he said.
The set menus of zero-fee ETFs also include those with less than $25-million in assets. Because many smaller ETFs are thinly traded, there can be a big gap between the price an investor is willing to pay, and the price demanded by the seller. "They trade at bigger bid-ask spreads, and that is a cost of trading ETFs," Mr. Gabriel said.
Vanguard ETFs are known for rock-bottom annual fees or expense ratios, but have few members on the lists of zero-fee ETFs. Still, long-term investors who pay a commission to buy and/or sell Vanguard ETFs should still come out ahead in terms of overall fees paid versus buying competing offerings, he said.
While most of the big bank discount brokers still charge a regular commission for trading any ETF, they have recently begun to slash their fee structures to be more competitive. TD Waterhouse, RBC Direct Investing and BMO InvestorLine have now switched to a flat fee with a maximum of only $9.95 or $9.99 per trade.
Yves Rebetez, managing director and founder of the ETF Insight Web site, said that investors should look beyond free trades to get the products they really need. "If you are a long-term investor … and it ends up costing $9.99 or $9.95 per trade, it's not a bad deal," he said. "If you are dealing in the tens of thousands or $100,000, it is going to be [even] less of a consideration."
Investors also need to consider factors such as available research tools or analytics too when buying ETFs, Mr. Rebetez added. "Not that you want to spread things around too much, but there is nothing that says that you can't try to work with more than one broker."