Amidst heated competition, Charles Schwab & Co., TD Ameritrade and Fidelity, among others, have eliminated transaction fees for online trading of ETFs and common stocks. Schwab eliminated its fees on October 7 and its competitors immediately followed suit.

This is terrific news not only for our Professional Asset Management (PAM) clients, who utilize these custodians, but for all investors. Portfolios can be rebalanced more cost effectively and year-end tax swapping strategies can be implemented more readily(see “Year End Tax Considerations, page 76, for more detail). Investors with smaller portfolios benefit in particular.

The “march to zero” began over 40 years ago, on May 1,1975. Until then brokers charged a fixed-rate commission for stock trades (ETFs did not exist), regardless of the size of the trade being placed. This was a wonderful arrangement for brokers, but not so much for smaller investors. The brokerage industry fought the SEC to retain the fixed-rate structure but lost.

Discount brokers, led by Schwab, quickly emerged. At the same time the cost of placing, routing and executing orders was falling dramatically thanks to advances in information technology. As competition increased, brokers offered various fee arrangements designed to soften the blow to their bottom line, such as tiered structures based on trade size and minimum account balances. At the end, however, zero was inevitable.

How do these firms stay business if they are assessing $0 for trades? The term “broker” is a bit vague. These firms are in fact also custodians of client assets, and as such they derive revenues by other means. These include securities lending, margin loans,and fees generated through expense ratios assessed in proprietary money market funds and ETFs.

Many conventional mutual fund trades, unlike ETF trades, will continue to incur fees, but this does not mean ETFs are inherently better. Mutual funds retain certain advantages; for example, partial shares can be purchased and dividends can be efficiently reinvested. Fund families such as Dimensional Fund Advisors also employ
trading techniques and practices that index ETFs (as well as index mutual funds) do not. The optimal choice depends on the asset class and investor preferences.

Also in This Issue:

Quarterly Review of Capital Markets
Year End Tax Considerations
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow-Jones Industrials Ranked by Yield
Recommended Investment Vehicles

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