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What to Make of Schwab’s ETF Price Cut

Charles Schwab won headlines Friday with its promise to cut annual investment fees on its line of market-tracking exchange-traded funds. But investors hoping to score a deal still need to do the math.

The online brokerage, which began offering its own ETFs in late 2009, has always used price as a selling point. The company now plans to slash fees to levels not previously seen. For instance, the annual levy on the $890 million Schwab U.S. Large-Cap ETF (SCHX), will be cut to just $4 a year per $10,000 invested, from $8. The new rate is less than half the $10 a year charged by the widely followed $118 billion SPDR (SPY), which tracks the same slice of the stock market. “We want to offer investors the lowest-cost solution,” says Schwab’s Managing Director of ETFs Eric Pollackov. “It’s the one thing we can contol.”

A no-brainer, right? Perhaps for some. But for most investors the choice is still pretty complicated. One big reason is that, while previous rounds of price cuts have helped companies like Vanguard Group upend the ETF world, investment fees on most funds are now already so low that other factors like trading costs can often have a bigger impact on investors’ bottom lines.

For most investors, the first thing to decide isn’t which ETF to buy, but whether to buy an ETF at all or a conventional index mutual fund with a similar investment strategy. For those that sock away a little each month or quarter, conventional funds are usually a better deal regardless of an ETF’s fees, because investors can buy them without paying brokerage commissions.

To be sure, currently Schwab lets investors trade Schwab ETFs commission-free in online Schwab brokerage accounts. But investors at Ameritrade ($9.99 a trade) or Merrill Edge ($6.95) could easily erase all savings on investment fees with just a few buy orders.

Commissions aren’t the only ancillary cost. There is also the bid-ask spread, the small price mark-ups investors pay to market makers when they trade. According to Morningstar, the spread on Schwab’s Large-Cap ETF, amounts to $3 per $10,000 invested versus $1 for the SPDR, cutting into the Schwab fund’s advantage on fees. Such discrepancies can be even more dramatic on funds that track harder-to-trade securities like bonds or emerging market stocks. They can also be wider at certain times of day like market open or close.

Finally, there is the question of how well any given fund tracks the corner of the stock market it targets. For Schwab U.S. Large-Cap ETF fund holders this has likely loomed far larger during the past year than fees. While the better-known SPDR tracks the Standard & Poor’s 500, Schwab’s version follows the Dow Jones US Large-Cap Index, a benchmark that includes about 750 names, giving it more exposure to middle-sized companies. Recently that discrepancy has hurt. The S&P 500 returned 27.97% over the past year versus 27.53% for the more inclusive Dow Jones version. The difference for investors — $44 per $10,000 invested – may look small on paper, but it swamps the difference in costs.


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