'Homing' In On Brokerage Fees

by: Martin Small

Five or ten dollars may not seem like much to buy a low-cost ETF. But when you think about it in percentage terms, those dollars can add up. Martin explains.

I rented my first apartment while attending college in Providence, Rhode Island, in the 1990s. What seemed like a stretch then feels too good to be true in today's dollars. The rent was $350 per month, utilities included!

A rental agency broker helped me find the apartment. Much to my chagrin, the rental broker's commission - the charge for her services - was one month's rent. The yearly rental payments totaled $4,200 ($350 X 12 months), but my first year really cost me $4,550. That's almost 10% more, just to tip out the broker for combing local listings. I didn't know any better. I later learned about no-fee brokers when I moved to New York after college. That ignorance cost me $350.

When you consider buying stocks, bonds or exchange-traded funds (ETFs) for your investment portfolio, you are faced with similar decisions. An ETF is traded like a stock but is a professionally managed, diversified portfolio, which means there's generally a small fee involved. That expense ratio is like the annual rent. But there can be an additional charge to buy an ETF: a brokerage commission. Brokerage commissions on investments can make rental agent commissions look tiny.

A better deal

Consider this example. A number of well-known retail brokerages charge a commission of $4.95. At this rate, if you were to purchase a broadly diversified, total U.S. stock market ETF, like the iShares Core S&P Total U.S. Stock Market ETF (NYSEARCA:ITOT), its annual expense ratio is 3 basis points. For a hypothetical $10,000 investment, 3 basis points is $3 per year. If you pay a $4.95 commission to purchase ITOT, the commission amount is 165% more than the total annual cost of holding the investment. That's like a rental agent broker charging you more than a whole year's rent, plus 65% as a commission. You'd think twice about that deal.

The good news for investors is that the highly competitive forces in retail brokerage have pulled brokerage commissions lower, and recent price competition has only intensified. Just five years ago, in 2013, the headline simple average commission rate for three name-brand retail brokers - Schwab, Fidelity and TD Ameritrade - was about $9. Today, that commission simple average is about $6, between 30% and 45% lower; commissions commonly show up at $4.95. Even better, some of the major retail brokerages have instituted large-format "no transaction fee" programs for ETFs. These programs are like no-fee rental agencies. They allow you to keep more money in your investments working towards long-term goals. Lower commissions help all investors, particularly those who are new to the market, by reducing hurdles to getting started.

Bottom line

When we look to buy or rent real estate, the commissions are typically top of mind. They are a cost we explicitly consider in addition to the annual cost of carrying a property. I think if real estate commissions were like investment brokerage commissions, we'd pay a lot more attention to no-fee listings.

This post originally appeared on the BlackRock Blog.