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ETF Price Wars: A Good Thing or Just More Hype?

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Fidelity has fired another salvo in the ongoing ETF price wars with the introduction of a number low cost sector ETFs.   Schwab, TD, Blackrock, Vanguard, and others have also participated in this price war in one form or another over the past couple of years.  Low ETF expenses and low or no transaction fees are a good thing, but should they be the deciding factor in your decision where to invest?

ETF Price Wars:  A Good Thing or Just More Hype?

Understand what you are buying 

As we’ve learned from the PBS Frontline special The Retirement Gamble among other sources, low investment costs are a key determinant accumulating a sufficient retirement nest egg.  The first and most important factor in choosing an ETF to include in your portfolio is to understand what the ETF invests in.

An ETF that tracks an index such as the S&P 500 is pretty simple.  However ETF providers are introducing new products seemingly every day.  According to Chuck Jaffe in a MarketWatch article, a Vanguard report found that “1,400 U.S. listed ETFs track more than 1,000 different indexes. But more than half of these benchmarks had existed for less than six months before an ETF came along to track it.”

Beyond commissions and expense ratios 

Fidelity recently published an excellent piece on its site, Beyond Commissions: An ETF’s Price Matters.  According to the article:

“Commissions aren’t the only cost to consider when buying an ETF. Most investors compare expense ratios, but a less appreciated—yet important factor—is the bid-ask spread, which is the difference between the highest price a buyer is willing to pay for an asset (bid) and the lowest price at which a seller is willing to sell (ask). While investors should consider the Net Asset Value (NAV) of an ETF, the price you pay is a seller’s ask price, which can be at a discount or premium to the NAV.

“It’s important to remember that not all ETFs are created equal,” says Ram Subramanium, president of Fidelity brokerage services. “So, investors may want to look for ETFs with established track records and low bid-ask spreads relative to their peers.”

As an interesting aside here, one of the low cost sector ETFs that Fidelity recently introduced was its materials ETF Fidelity MSCI Materials ETF (FMAT).  This ETF competes directly with the Vanguard Materials ETF (VAW) and has an expense ratio of 0.12% vs. 0.14% for the Vanguard ETF.  However the recent bid/ask spread for the Fidelity ETF was 11.68% vs. 1.57% for the Vanguard ETF (according to Morningstar).  The passage above from the Fidelity article might indicate that the older, more established Vanguard ETF is a better choice here.

Other factors to consider

  • Unless you are a frequent trader or you are purchasing ETFs in small dollar amounts trading commissions really shouldn’t be a major factor in your ETF investing decisions.
  • Consider the full breadth of the investment products available to you as well as your investing objectives when choosing an investment custodian.  ETF price wars are much like loss leaders in retailing.  Major custodians such as Fidelity are using low cost ETFs to get you in the door and to hopefully entice you to use their services to invest in mutual funds, stocks, and other investment products via Fidelity.
  • Are the commission-free ETFs the right ones for your portfolio?  For example a number of the ETFs offered on Schwab’s commission-free platform are not ones that I would generally choose for my client’s portfolios.
  • How cheap is cheap?  I doubt that selling one ETF and buying another to save say 0.02% on the expense ratio makes sense, especially if there are transaction costs or capital gains to consider when selling.
  • How well does the ETF track it’s benchmark index?  I’m often surprised by the variations when comparing two ETFs that I would assume to be identical other than the name of the ETF provider.

 

Are ETF price wars a good thing for investors?  Yes.  Are ETF price wars being used by major custodians and ETF providers to create hype in the financial press in order to lure investors?  Again yes.  The bottom line here is that your financial plan and investment strategy should guide your choice of ETFs, mutual funds, or any investment vehicle, not a slightly lower cost or the lure of free trades.

Please contact me with your investing and financial planning questions. Check out an online service like Personal Capital to manage all of your accounts all in one place or purchase the latest version of Quicken. Check out our Resources page for more tools and services.

Photo credit:  Flickr

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