What’s better than an ETF? A commission-free ETF!
Ain’t nothing like sidestepping commission to put a pep in your step, am I right? Wendy inquired about these products in the clubhouse, and since I’ve used them in the past and possess opinions galore, I decided to dedicate today’s commentary to the topic.
The Fine Print
Commission-free ETFs have grown in popularity and are now offered by most mainstream brokers (TD Ameritrade, Schwab, Fidelity, etc…). As the name suggests, your broker allows you to buy and sell them without having to pay commission. There are a few rules, however. While they may differ broker to broker, here are those required by TD Ameritrade. Really, it’s one rule.
You have to own the fund for at least 30 days. If you sell it within that period you will be charged commission.
That means these can’t be used for day or swing trading. They are designed to be longer-term investment vehicles.
The dodging of paying commission is the sole benefit. Now, think about who this helps the most. It’s not the investor who throws a big chunk of money into stocks once a year. Avoiding a $5 commission doesn’t even move the needle if it’s paid once a year and you’re investing $10k each time. It’s the investor who’s buying small increments frequently that was dancing in the Street when these products came online. Say you wanted to buy $100 of U.S. stocks every month using the SPDR Portfolio Total Stock Market ETF (SPTM). At $30, you’d be buying three shares every month. If you have to pay $5 every time you invest $100 that means the fund you’re purchasing has to rise in value 5% just to pay for your commission.
Talk about a buzzkill! No way you’re going to be successful with that type of transaction cost. Thankfully, commission-free ETFs solve that problem. If you want to buy one share a day, no sweat. Transaction costs are no longer an issue.
The Liquidity Problem
The principal problem you’ll run into with most commission-free ETFs is they don’t have much liquidity. That means their average daily trading volume is in the tank. And if they have listed options then the bid-ask spreads are probably wide enough to drive a truck through. Buying 100 shares of an illiquid ETF for the sole purpose of saving $5 only to get dinged every single month after that as you try to sell crappy call options is a bad idea.
Ameritrade used to have a decent list of candidates, but they made changes this year and removed most of my favorite ones (they were all Vanguard ETFs and most had listed options). The new batch of ETFs are very illiquid, and hardly any have options. And those that do aren’t actively traded at all.
How I’ve Used Commission-Free ETFs
I invest money for my kids every month, and when that account started out, I was dollar-cost averaging into commission-free ETFs. At the time, Ameritrade offered much better ones to choose from. Here’s the list of the ones I used (VTI, VB, VEA, VWO, LQD, SHY, VNQ, IGE). My goal was to increase the account size until I could buy 100 shares of a liquid ETF for each category (large-cap, small-cap, emerging markets, etc…). Then I would swap out the commission-free ETF with a liquid alternative (SPY for VTI, IWM for VB, EEM for VWO, etc…). I obviously had to pay the commission for the more liquid ETF and then started selling covered calls.
If I were restarting today, I might do it the same, but I must admit Ameritrade did traders a disservice with their recent change of which ETFs are available.