ETFs vs. Mutual Funds: Fidelity Continues Game Changing Trend

Last Updated Feb 3, 2010 10:58 AM EST

Fidelity has just announced that it will no longer charge commissions on 25 exchange-traded funds, which is changing investing when it comes to ETFs and mutual funds. This follows Schwab's announcement last year waiving commissions on its own ETFs and brokers, such as Zecco, offering free trades of any ETFs or stocks, with certain restrictions.

ETFs are great for one-time big investments since their costs are generally lower than mutual funds, but they don't work so well for investors who build a position with smaller, regular installments. That's because, unlike mutual funds, ETFs trade on a stock exchange, and you pay a commission every time you invest. Fidelity has blazed new trails by eliminating commissions on ETFs.

This is a very good thing. That is not to say, however, that you should just jump in. Fidelity is eliminating commissions for at least three years, but that doesn't mean they are eliminating total costs. Keep the following in mind:
  1. Commissions are only part of trading costs. Bid-ask spreads must still be paid with every trade that you don't have with mutual funds.
  2. ETFs can typically only be bought in whole shares, where mutual funds can be bought in fractional shares. This makes regular purchases of ETFs more difficult.
  3. iShares ETFs have low costs though they are not always the lowest. It might still be better to pay the commissions to buy Vanguard ETFs, as lower expense ratios may ultimately be a lower-cost way of investing.
Watch out for the tactic of a brokerage firm bringing you in for a great deal only to sell you more expensive products, such as a managed account with a one percent annual fee. It's the same tactic the supermarket uses in putting the milk on sale at the back of the store knowing you'll pick up a dozen other full priced items before you leave.

Lower costs are always a good thing. Hats off to Fidelity and iShares for the service they are providing to investors.
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    Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to over $50 million. The author of How a Second Grader Beats Wall Street, Roth teaches investments and behavioral finance at the University of Denver and is a frequent speaker. He is required by law to note that his columns are not meant as specific investment advice, since any advice of that sort would need to take into account such things as each reader's willingness and need to take risk. His columns will specifically avoid the foolishness of predicting the next hot stock or what the stock market will do next month.

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