Monday, October 24, 2011

Commission-Free ETF Trading

Scotia iTrade was the first online brokerage to offer commission-free ETF trading and now Canadian Couch Potato reports that Qtrade is offering commission-free ETF trades as well. Saving money on commissions this way is a good thing, but it can mask problems.

I find trading similar to drinking: they’re both fun, make me feel good, and cost me money. I try not to be too anxious to get duty-free booze at the border. I have no problem with saving money, but I worry that if cheaper bottles of booze makes a significant difference to my finances, maybe I’m drinking too much.

Getting back to ETF trading, it’s better to pay nothing than something, but if you’re really saving a lot of money with free ETF trading, maybe you’re trading too much.

There are other hidden costs of trading that are less apparent than commissions. You pay half the spread on each transaction and you pay for trading against better-informed investors, some of whom have inside information (or at least information you don’t have).

So, go for the free ETF trading if the available ETFs fit your investment plans, but remember that your investing strategy is more important than a few dollars for commissions. Don’t let the tail wag the dog.

9 comments:

  1. I'd rather have a bottle in front of me than a high trading cost?!? Maybe that's not how it goes

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  2. It probably matters more to folks with small portfolios. Now there is no longer a reason to pick mutual funds over ETFs to run a couch potato strategy: even with $1000 you could get into half a dozen funds and rebalance using your biweekly contribution.

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  3. @Patrick, I would argue the opposite. Spreading $1,000 across half a dozen funds is massive overkill. Even for accounts of $30,000 to $50,000, a simple portfolio of TD e-Series funds is just fine.

    I've heard from a lot of investors who are attracted by the zero commissions, but they forget that Claymore's equity ETFs have MERs of 0.72%, which is about double that of TD's e-Series funds.

    As MJ suggests, the zero commissions may also encourage too much trading/rebalancing. The 90 day minimum holding period for mutual funds is often a good thing for impulsive investors.

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  4. @Big Cajun Man: It seems that my analogy derailed your thinking :-)

    @Patrick and @Dan: I think Patrick's conclusion depends on which ETF can be traded commission-free as Dan points out. If all ETFs could be traded without commissions, then Patrick's conclusion that there is no reason to prefer mutual funds for small portfolios would follow. MERs would drive the ETF or mutual fund decision. But as Dan points out, the ETFs that are available to trade commission-free don't necessarily compare well to TD eSeries funds on MERs.

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  5. That's a good point from Canadian Couch Potato. I'm strictly in stocks, but I usually think of ETFs being cheaper than mutual funds. Maybe generally true, but clearly not always.

    I guess the rationale behind free ETF trades is the brokerage gets trailer fees on them, or a bonus from the ETF company? Anyone?

    I agree with your drinking analogy, Michael. After every $10 trade, I consume $10 in beer. This keeps my trading to a minimum, as I'm usually too... uh... sleepy to complete a second trade.

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  6. @Gene: I'm not sure of who pays for the trading costs when we get free ETF trading. No doubt there is some sort of contractual arrangement.

    $10 in beer for each trade, eh? Maybe I should reconsider my position on minimizing trading.

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  7. I always find it interesting that brokerages always use the word "trading" and not "investing" :)

    Good post Michael, will include the weekend roundup.

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  8. @Mark: There is a certain amount of honesty in the brokerages calling it "trading" because this is their main concern. They don't really care how your investing is doing.

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  9. @Dan: Sorry, I don't follow. How does is the desirability of diversification affected by the size of the portfolio, if there are no trading commissions?

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