Commission-Free Exchange Traded Funds And Mutual Funds. Which Is Better?

The bigger brokerage firms are beginning to offer a set of Exchange-Traded Funds that you can buy and sell without paying a commission. Each firm has a different list of commission-free ETFs, but in most cases there are enough options to consider building your portfolio around them.

Exclusively using commission-free ETFs could save you thousands of dollars in fees over your life time, allowing you to invest that money instead of your broker profiting off of it. That could result in a significantly larger portfolio for you over the years.

Do these new sets of ETFs put mutual fund investing at risk? Should you abandon mutual funds completely in favor of these commission-free investment products? Which is really better; ETFs or mutual funds?

Factors to Consider When Deciding Between Commission-Free ETFs and Mutual Funds

There are three big factors to look at before you make the plunge into either investment:

Can You Build Your Target Portfolio?

Getting commission-free trades on ETFs is a great thing and makes investing with them very similar to investing directly with a mutual fund company like Vanguard or T. Rowe Price. Being able to buy more shares without incurring additional costs makes it easy to set up automatic investing.

As nice as those perks are you are somewhat limited with commission-free ETFs simply because the brokerage firm is only going to include certain ETFs in that pool of investment options. Some of those ETFs are highly illiquid and that carries with it problems and costs.  Your target portfolio may include specific sectors of the global economy that are not covered by the commission-free options. In that case you would need to either invest in other ETFs (that do require a commission to be paid) or in a mutual fund; both can negate the value of the pool of commission-free ETFs.

If you can effectively build a quality portfolio that meets your desired asset allocation using only the exchange-traded funds that do not have a commission associated with them, do so. The only difference between that investing strategy and using mutual funds is you can trade in and out of your ETFs during live market hours rather than waiting until close of markets before your mutual fund shares are exchanged.

Neal’s notes – Commission free investing is great.  So is low cost funds.  But at the end of day, your investment approach and strategy is far more important.  These are the success ingredients that really make the difference over the long haul.  There are times that low cost /no commission ETFs are the way to go. But if your goal is to have enough money to retire, don’t lose sight of the forest as you inspect the trees. Grow your money safely and avoid taking on undue risk.  If that means you have to pay a few more pesos in fees or commissions, so what?

Expense Ratio Costs

Commissions on exchange-traded funds are just one piece of the cost puzzle for investors. One other huge piece is the expense ratio associated with your investments. With the industry average for mutual funds hovering around 1% (when including both passive index funds and actively managed funds), ETFs can make an appealing case with lower expense ratios.

However, there are index mutual funds available from large fund companies that offer extremely competitive expense ratios when compared to ETFs.  In many cases, they charge less than comparable ETFs.

Ease of Investing

Lastly you need to consider the ease of investing to your target asset allocation.

Depending on your target asset allocation you could achieve the same results with commission-free ETFs. If you can build your entire portfolio using those ETFs simply set up automatic investments to be traded into the funds according to your target allocation. For example if you invested $100 per month and wanted 50% in the stock ETF and 50% in a bond ETF you would set up a $50 trade into each.

As with any other portfolio you need to rebalance at least once per year to make sure your allocation stays on track.

Should I Invest with Mutual Funds or Commission-Free ETFs?

If you are looking for a black and white answer to this question, it doesn’t exist. As with most investing questions it truly depends on your situation. Asking the right questions will help you make a smart investing decision. What is your target asset allocation? Are there commission-free ETFs that can meet 100% of your investing needs inside the portfolio? What expense ratios do those ETFs have and how do they stack up to equivalent mutual fund shares you could get without paying a commission?

The bottom line: it isn’t cut and dry that ETFs without commission fees are automatically better than mutual funds. Do your research before you jump in.