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Index Funds vs. Commission-Free ETFs

Tuesday, April 6, 2010   

I love index funds.  Their low costs have historically translated into high returns, they greatly simplify the difficult task of portfolio management, and they perfectly complement a disciplined, long-term investing approach.  Do-it-yourself investors can’t go wrong with a risk-appropriate portfolio of low-cost index funds, and Vanguard is still the only one-stop shop when it comes to building an index fund portfolio.  Index funds form the backbone of every portfolio recommendation on Invest-it-Yourself.com. 

That being said, recent developments in the Exchange-Traded Fund (ETF) marketplace are causing index investors to re-examine the case for ETFs.  Since their introduction in 1993, ETFs have offered many of the same advantages as index-based mutual funds, as well as increased trading flexibility and lower expense ratios.  Until recently, however, ETF trading commissions were a deal-breaker for investors who make small, regular contributions to their accounts.  Well, times have changed.   Schwab (eight commission-free ETFs) and Fidelity (25 commission-free iShares ETFs) are now offering commission-free ETF trades, joining firms like Wells Fargo, who continues to offer 100 free trades per year with a combined minimum of $25,000 in brokerage and checking assets.  I consider these low-cost offerings to be a major development for long-term investors, especially if more firms follow suit.

Before you jump on the ETF bandwagon, however, let me give you a few words of caution.  First of all, commission-free trading doesn’t guarantee an inexpensive product; be sure to compare expense ratios, bid-ask spreads, and all other fees prior to investing.  Secondly, sticking with your long-term investment plan is much more important than choosing the right investment vehicle.  Before moving assets to a new brokerage firm, ensure that your new setup will provide all of the funds and services necessary to stay aligned with your Investment Policy Statement.  Finally, be aware of short-term trading temptations.  Prominent indexing advocates like Jack Bogle and Warren Buffett have voiced concern that ETF trading could cause investors to stray from a long-term, disciplined investing approach.  If you aren’t comfortable with ETF trading, stick with low-cost index funds.

The chart below lists some popular ETFs, including some of the commission-free offerings from Schwab and Fidelity, organized by asset class.  As you can see, it’s still tough to beat the selection of low-cost index funds available at Vanguard, but ETF investors have more competitive options than ever before.  I hope to fill in the blanks as more commission-free ETFs become available in the coming months.

Asset ClassVanguard
Index Fund
Schwab
Commission-Free ETF
iShares
Commission-Free ETF
(through Fidelity)
Other
ETF(s)
US Equity - Total Stock MarketVTSMXSCHBIWVVTI, TMW
US Equity - Small Cap ValueVISVXSCHV+SCHAIJSVBR, DSV
Int'l Equity - All-World ex-USVFWIXSCHF+SCHEEFA+EEMVEU, GWL
Int'l Equity - Small CapVFSVXSCHCSCZVSS, GWX
Int'l Equity - ValueVTRIXEFV
Bonds - Total Bond MarketVBMFXAGGBND, LAG
Bonds - TIPSVIPSXTIPIPE
Bonds - MunicipalsVWITXMUBTFI
Real Estate (REITs)VGSIXVNQ, RWR

*Note:  Vanguard announced their own lineup of commission-free ETFs on May 4, 2010.  Check out this updated chart of commission-free ETF offerings.

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Posted by George | Index Funds & ETFs | Comments (0)
 

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