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Schwab: Commission-Free ETFs Not a Gimmick

Scott Burns

Scott Burns: Schwab makes a big splash in the ETF market. Hi there, I'm Scott Burns, director of ETF analysis with Morningstar. I'm joined today by Charles Schwab's Peter Crawford, who is the senior vice-president of Investment Management Services with Charles Schwab. Peter, thanks for joining me.

Peter Crawford: Thanks for having me.

Burns: So, Schwab entering the ETF market. A couple things. One, incredibly low-cost funds that you're coming out with. Let's talk about why ETFs, why now, why Schwab.

Crawford: Right. Well thanks, Scott. Schwab is actually not new to the ETF market. We're already a major player in the ETF landscape. Roughly 20% of the retail ETF assets are held by clients of Schwab and the independent advisors that we work with.

So we saw an opportunity, as the popularity of ETFs has been exploding in the last several years, to move from that really strong foundation of being a major distributor to being a manufacturer as well. And in doing so, to provide our clients with an exceptional value, which is market-leading expense ratios on our ETFs, coupled with free online commissions for Schwab clients when they trade these ETFs in their Schwab accounts.

Burns: Right. That's really, I think, the biggest news of this. Not only did you come out with some really nice core funds that are really low cost, you have waived the trading commissions for anyone on the Schwab platforms trading Schwab ETFs.

So I guess the question is, is this a teaser rate? What are we looking at here?

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Crawford: This is not a promotion. This is not a teaser. It's not a gimmick. There are no catches, no caps. This is our ongoing commitment to the ETF pricing in making these commission-free.

Burns: Right. So I know about Schwab's commitment to the small investor, but there's something in it for you. So for Schwab, when we look at no commission, on top of helping investors, it's going to help you out in other ways, correct?

Crawford: Well, Schwab's philosophy is that if we delight our clients, if we continue to find ways to make our clients happy, that they will reward us by bringing us more of their business, but also telling their friends about us and referring more friends. And that's why most of our new client acquisition comes from referrals.

And so that has been our approach for many, many years and that has what has helped us have positive asset flows into Schwab, even during challenging market times.

Burns: So with no commissions and the really low costs, this is clearly one of the most investor-friendly moves in the fund industry, I would say, in the past five years, decades, and I think it's in the top five, top 10 ever when we look at it.

And it's not just because of what it means for Schwab investors. I do think that the ETF industry and ETF investors will benefit in general.

Crawford: Absolutely. And I think what's exciting about this is this appeals to all different types of clients. So for the more active traders, clearly they're going to like the no commission. For the buy and hold investors, these expense ratios and the diversification tax efficiency you get with ETFs anyway are really, really compelling.

But it also allows ETFs now to be a potential vehicle for smaller investors. So you think about an investor who might be wanting to dollar-cost average into the market. Say they put $200 a month into the market to leg into the market.

Well if that investor has to pay $10 or $12 every time they do that, well that's 2% of their principal they are paying for the trade. The expense benefit of an ETF doesn't make sense in that scenario. But with this, with the move that we are making, suddenly ETFs are a great product, a great solution, for those smaller clients.

Burns: Right. So it really removes that transactional friction cost that does keep--as great as they are for small investors--the reality is it does keep a lot of them out.

Crawford: Absolutely. We look at this in very similar to when we launched the mutual fund marketplace a decade and a half or 20 years ago now in terms of our one source platform and trying to find a better way to serve clients. And that really led to an explosion in the popularity of mutual funds and people saw the benefit of bringing all their mutual funds together in one place. Schwab became known as the place for mutual fund investors. We see this as an opportunity to become the place for ETF investors, as well.

Burns: So what do you think the future of ETFs is? As a market adoption, what is kind of Schwab's big picture view of this fund structure?

Crawford: Well we're certainly very, very bullish on ETFs and on continued growth. As you know better than anyone, they have grown enormously in the last 10 years. They made that migration from the institutional investors to the independent advisors, now to some other more sophisticated individual investors.

We see that trend continuing. As we look at our advisor community, roughly 40% of them say they want to invest more in ETFs in the years ahead. It's the number one product that they intend to invest more in.

As we look at our individual investors, as much as we talk about ETFs and as popular as they are, only 16% of our clients actually use ETFs today. So that means there is another 84% that may want to use them in the future.

So we see just enormous opportunity for growth. And that's, again, another reason why we want to make sure we're right in the middle of that growth.

Burns: Right. Well, not to be too glowing, but I do think you've come out with some really great products at even better prices. And the no commission, I think, for investors, it's a win. I hope it's a win for Schwab, and good luck to you guys.

Crawford: All right. Thank you very much.

Burns: Thanks, and I'm Scott Burns, director of ETF analysis. For this and other ETF information, please check out Morningstar.com's ETF Center and Morningstar's ETFInvestor newsletter.