Exchanged-traded funds are a great investment tool with low expense ratios that can be used to build a diversified portfolio quickly. ETFs can also be used to segment part of your portfolio into various niches that interest you. And the story gets sweeter. You can even buy ETFs without paying a commission as I wrote about recently.
That being the case, it might seem like a no-brainer to buy ETFs – especially the commission free version. But I suggest that you slow down. Let’s consider the benefits and drawbacks before you pull the trigger.
Positives and Negatives of Commission-Free ETF Trades
Not having to pay commissions on ETF trades sounds like a great deal. And it can be. But there are some negatives to be aware of before you completely move your portfolio to only ETFs.
Upsides of Not Paying a Commission on ETF Trades
Never Pay a Commission Again
The most obvious upside to the commission-free ETFs offered by your broker is that you will never pay a commission on those specific ETFs. That means that if you research the ETF carefully you could build an entire diversified portfolio, enjoy the minimal expense ratios, and not pay an extra dime in fees to the broker. Nice.
Trade During The Day
Another upside is you can trade in and out of ETFs during the day. You don’t have to wait until the end of the trading day (or the end of the next business day’s trading day) as you do with mutual funds. ETFs are traded like stocks on the stock exchanges so you can buy and sell whenever you like. When you don’t have to worry about commissions for your broker you can trade as frequently as you like. (Please note that some brokers charge you a fee if you trade out of a commission free ETF within 30 days of purchase.)
Dollar Cost Averaging Works
Never paying a commission to invest in an ETF means you can continue to dollar cost average your portfolio. Paying $4, $7, or $10 per trade or more makes automatic investing with exchange traded funds a poor financial choice. The commissions eat up the expense ratio savings and then some. By removing the commission from the equation you don’t have to worry about the costs eating up your savings, allowing you to continue to dollar cost average in your investments each month.
Downsides of Not Paying a Commission on ETF Trades
Of course there are some downsides with any investment, and commission-free ETFs are no exception.
Select ETFs Only
The first major issue is that only a select number of ETFs get the commission-free treatment at most brokerage firms. Your ability to build a complete portfolio will be determined by which ETFs are offered and whether or not they fit into your desired portfolio.
As with any trade on a stock exchange there is an ask/bid spread where the middle man makes his money. If you want to invest in this type of investment, you have to accept that there is a spread that impacts you. Often the broker only offers commission free ETFs that have very little volume. That means they are not very liquid and investment liquidity is very important. As liquidity declines the spread between ask and bid widens. That can be very expensive for traders. If you only trade commission free ETFs you could end up spending a lot more money on this spread than you save with the commissions.
Tracking the Right Index
Even if you technically can put together a portfolio using ETFs it may not be as well diversified as a different mutual fund option (or commission-required ETF). For example, your broker might offer you a stock index ETF that tracks the Wilshire 5000 instead of the S&P 500 or a US-only bond index tracking ETF instead of a global bond ETF.
Are Commission-Free ETFs Right for You?
Whether or not you should invest with commission-free ETFs over other ETFs or mutual funds depends on your investing goals. If you can legitimately use the ETFs offered without commission, there is no reason to not use them. If it is a bit of a stretch for you to justify using those specific ETFs you may be better off with a mutual fund or a commissioned ETF.
Do you restrict your investments to ETFs which are commission-free only? Why or why not?