No-Commission ETF Trading Gains Steam

By Murray Coleman

The old adage that exchange-traded funds aren't wise investments if you're dollar-cost averaging or making small purchases just isn't true anymore.

In the past year and a half, at least three major brokerages have started offering no-commission trades. That basically shoots down the biggest rap on ETFs over index mutual funds.

So how is the advent of no-commission ETFs panning out?

Pretty impressively, so far, at least. Let's take a look at where the ETF pricing revolution has come in the past year.

From The Start

Wells Fargo (WFC) Investments began offering 50 free ETF trades a year per account in June 2005. That plan also included stocks and the old dogs on the block, traditional muts. The only catch was that you had to have at least $250,000 with the bank to qualify.

Even with such a high minimum, the response was strong enough that last February Wells Fargo decided to expand its free-pricing platform. It lowered the minimums to $25,000 and bumped up the number of free trades to 100.

And let's emphasize that's per account. So if you've got an IRA, you get 100 free trades. If you've got a taxable account, that's worth another 100 free trades per year.

For example, I've got a rollover IRA, a Roth IRA and a traditional IRA along with a taxable account through the brokerage's free-trading program. In theory, I could make 400 free trades a year ... something that's unlikely to ever happen.

And unlike its other major rival, Bank of America (BAC), the Wells Fargo offer doesn't require you to leave a certain amount in a low-interest savings or checking account. You're forced to open what's called a PMA (Portfolio Management Account). It's basically a souped-up checking account without any minimums unto itself.

The PMA checking account serves as a link to the brokerage side of the business. Any combination of investment dollars and/or PMA deposits on the books is good enough to qualify for free trades.

But there are similarities. Both Bank of America and Wells Fargo demand at least $25,000 upfront to qualify for free-trading. And each throws in access to a wide range of other free banking as well as brokerage services. Still, those common traits at least in my mind are trumped by Wells Fargo's more flexible requirements on what you can do with that initial $25,000 to open an account, (i.e., you don't have to keep at least that much in a relatively low-yielding deposit account at all times).

Free Trading Spills Into Other Areas

In the little over a year that Wells Fargo has been providing free trades, it says business is booming. "We saw a 42% increase in the fourth quarter of 2007 over the same period the previous year in number of accounts. And assets linked to the PMA accounts went up 34%," said Jeff Cornman, a Wells Fargo vice president.

"That's really telling the story that our new pricing resonated with the public. They've really brought in a lot of new assets," he added.

With so many new accounts opening, "a large percentage of the asset growth is coming from new clients," Cornman said.

And he stresses that the current pricing will remain permanent. "We rolled out free-trade pricing on a limited basis two and a half years ago. So we really took that time to study the type of business this generates. Based on those results, we felt very confident in moving forward by expanding the program."

Promises, Promises, Promises

Well, anyone who has jumped on these discount trading platforms in the past has probably heard the same sort of promises before. This time, some positive signs are on the horizon that these new free-trading offers might stick. For one, Wells Fargo says it's aiming for its investments side to contribute a quarter of the company's total earnings in the future.

In 2007, brokerage and related activities represented about 16% of the company's earnings.

"Wells Fargo is committed to the investments business. It's a core part of the bank's overall strategy. And we see this pricing program as key to building long-term relationships with clients," Cornman said.

In other words, the bank wants more investors who can use Wells Fargo for their credit cards, home loans and investment purchases.

Along those lines, Wells Fargo says it's seeing a healthy increase in deposits into the banking side of the business. "Those same clients who brought in brokerage assets also increased their overall relationships in other types of accounts with the bank," Cornman said. "They're also putting money into CDs, checking accounts and savings accounts."

Bank Of America Enters Fray

Even though this is a column, I still don't want to open myself to complaints of favoritism. For the record, I also bank at Bank of America. My main reason for going with Wells Fargo had to do with meeting account minimums.

But I also felt like no matter how big of a nest egg is involved, the idea of making investors leave $25,000 on the table in a checking or savings account seems rather half-baked. The other problem I've got with the Bank of America offer is that it doesn't let you include any of your mortgages in the equation. Wells Fargo does, although it's a relatively small percentage.

Bank of America started offering free trading in ETFs in the second half of 2006. It's allowing 30 free trades a month, which is more than Wells Fargo. But those free trades are per account holder, not account. That can make a big difference depending on your style of investing.

Still, Bank of America is bigger and might have more branches in your area. I'd argue that shouldn't be a priority since the free-trading investment platform is Internet-based. And the banking sides at both operate fairly separately from the brokerages.

On the electronic end, Bank of America wins hands down. Its Web sites are much better than those of Wells Fargo. In terms of customer service, I'd give a slight edge to Bank of America.

Bank of America isn't making public any growth numbers for assets in its free-trading program. But a spokesperson did say: "We've seen significant growth in the number of new accounts being opened. New clients in the past year are bringing in larger account balances and trading more actively."

Don't Need $25,000

If you can't meet either brokerage's minimum, or want to stay away from dealing with big banks in general, there's another good option. Online broker Zecco.com is offering 10 free trades per month per account. The free-trading program requires only a $2,500 minimum, and started before Wells Fargo or Bank of America went down the same path.

"We've certainly seen various types of promotional pricing plans within the brokerage industry from time to time," said Michael Feser, president of Zecco Trading Inc. "But when the big banks made free trades a permanent part of their pricing models, it really validated what we were doing."

Zecco says it now has about 70,000 individuals trading through its platform. "ETFs are a very popular part of our online community," Feser said.

He estimates that a common benchmark among online brokers is that banking activity generates about 55%-60% of total revenues. Zecco offers savings and checking accounts as well as other financial services. It also makes money on the trading side through options and other types of sophisticated investment vehicles.

Feser, who also has served in the past as an online brokerage executive at E-Trade, JPMorgan's BrownCo and USAA Investment Management, says that trading costs keep dropping as technology improves.

The firm also doesn't maintain a brick-and-mortar presence, which helps it to limit overhead.

"Costs keep being driven down as Internet trading increases," Feser said. "Free trading is definitely the wave of the future."

A business that combines profit streams of traditional banks with volume-based Web discount brokering services is "very sustainable nowadays," he added.

Comments

[Ole]

Thanks! We have account in both WFC and BAC and we knew nothing about these account options. We hold and trade a number of ETFs through Schwab and Scottrade. But we'll be checking out the free ETF trading at WFC and BAC. Thanks again.

[huangthomas]

I have tried and I don't believe it's really free. If you redeem mutual funds shares, always check the net asset value (NAV) of the shares you redeemed from reliable sources. Don't believe in the number they gave you. Always use limit orders, so you know exactly what you are getting or paying. Keep a good transaction record preferably down load to your financial software so you have your personal record.

[huangthomas]

In my long experience with investment, I have never been charged with "miscellaneous expense" and credited with "miscellaneous income". You'll see these items in and out of your cash reserve at a mind boggling rate. Good luck.

[texan]

I have accounts at both WFC and BAC but just learned about the free trades in January so I bought a 25K CD at BAC and moved my investment account from a full service broker. At 30 trades a month I am saving $900 now each month. The only difference is after a stock sale the money is not available for another trade for 3 days where as the full service broker the cash was available for the next trade right away.