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Morningstar's Guide to Free ETF Trading

We look for the best of the bunch among commission-free trading programs for exchange-traded funds. 

Tim Strauts, 06/05/2013

Today, almost every major discount broker offers a commission-free trading program for exchange-traded funds. Brokerages are competing for investor accounts, and they are leveraging ETFs' popularity to lure investors. This competition among brokers has helped to reduce the cost of investing in ETFs. This article will highlight the pros and cons of the commission-free ETF trading programs offered by Fidelity, TD Ameritrade AMTD, Charles Schwab SCHW, E*Trade ETFC, Vanguard, and Merrill Lynch.

Unpacking the Total Cost of ETF Ownership
Before we get to the broker breakdown, it's important to remember that commissions aren't the only costs investors face when buying and selling ETFs. There are other implicit transaction costs to consider. For example, investors also should assess bid/ask spreads before buying and selling shares of an ETF. As a general rule of thumb, ETFs with large asset bases and high trading volumes generally will have lower bid/ask spreads than smaller ETFs with lower trading volumes.

Holding costs also must be considered. The most explicit cost of holding an ETF is its expense ratio. But much as is the case with trading costs, there are implicit costs to consider as well. Morningstar's estimated holding cost measure for ETFs provides a holistic assessment of both the explicit and implicit costs of owning an ETF. The implicit costs of ETF ownership include items like transaction costs, sampling error, and share-lending revenue. You can find an ETF's estimated holding cost at the bottom of the "Performance" tab on the fund's quote page on our website.

Breaking Down the Brokers
Picking a suitable brokerage service involves assessing a whole host of factors beyond commission-free ETF trades. These items include the trading tools on offer, the level of customer service, and whether or not access to research is offered. For the purposes of this analysis, we will ignore those aspects and focus solely on comparing the attributes of these platforms' commission-free ETF trading programs. In the tables below, you'll find several data points that summarize the key aspects of each broker's program. Most of the data is self-explanatory, but a few data points warrant further explanation.

The "Number of Morningstar Categories Covered" field provides a sense of the diversity of the selection of ETFs eligible for commission-free trades. Ideally, this list will cover a large number of Morningstar's 93 ETF categories in order to offer the broadest possible opportunity set and enable the construction of well-diversified portfolios. Also, while commission-free trades are great, they are quite a bit less so if the only options at your disposal are high-cost funds. The "Average Asset-Weighted Expense Ratio" data point shows the average asset-weighted fee being paid by investors in the ETFs on the list. Lastly, we rarely recommend investing in ETFs with less than $100 million in assets. These funds tend to be fairly illiquid and face a higher degree of closure risk than funds with an asset base greater than $100 million. Highlighting the percentage of eligible funds below the $100 million threshold provides a rough gauge of the quality of the funds within the program. 

In March of this year, Fidelity renewed and expanded its partnership with iShares. As part of the agreement, Fidelity beefed up the lineup of iShares ETFs available for commission-free trading to 65 from 30. The centerpiece of the lineup is the Core series of ETFs, a group of 10 funds meant to offer very competitive expense ratios and broad diversification for long-term investors. The rest of the list includes almost all of iShares' most popular funds. iShares MSCI Emerging Markets Index EEM, which has more than $40 billion in assets, is the only glaring omission from the iShares family. However, iShares Core MSCI Emerging Markets IEMG with its rock-bottom 0.18% expense ratio is a suitable alternative. Every major Morningstar category is represented on the list, and the average asset-weighted expense ratio of just 0.25% is very competitive.

Fidelity is currently planning to build its own family of ETFs. It can be assumed that any ETFs the firm launches will be part of the commission-free trading program.

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