The Future Price of Investing: Zilch
Could fees for investing ever fall all the way to zero? For investors in exchange-traded funds, that prospect is just three-hundredths of a percentage point away.
On Oct. 16, State Street Global Advisors slashed the cost of several funds, dropping the annual management fee of the SPDR Portfolio Total Stock Market andSPDR Portfolio Large Cap ETFs to 0.03 percent of assets per year. The funds join similar ETFs from BlackRock Inc. and Charles Schwab Corp. at that price. But it may not be the last move: ETF makers have been cutting costs wherever they can, most recently by creating their own market benchmarks to track so that they don’t have to pay licensing fees to index companies such as MSCI Inc. and S&P Global Inc. “My guess is that we’ll see the first mainstream 0.00 ETF in the next 18 months,” says Eric Balchunas, who analyzes ETFs for Bloomberg Intelligence.
As money managers compete to bring customers in the door, razor-thin costs are where the asset growth is. Of the $738 billion that investors put into index funds and ETFs in the past 12 months, $509 billion went to funds costing 0.1 percent or less, according to data compiled by Bloomberg. “Investors are really cost-obsessed, so these asset managers are betting if they lower the fees, they’ll make a little money because they’ll get all the assets,” says Balchunas.
For individual investors, the drop in costs can have a profound effect. If you were to invest $10,000 with annual expenses of 1 percent—not uncommon for actively managed mutual funds—the total cost over 30 years would be almost $15,000, assuming a pre-expense return of 6 percent per year. Drop the expense ratio to 0.03 percent, and you’d pay just over $500, according to the Securities and Exchange Commission’s online fund cost calculator.
It’s not only ETFs’ management fees that are falling. Unlike mutual funds, ETFs have to be purchased through a brokerage, like a stock. But increasingly, it’s possible to trade in and out of them with no commission. Trading in individual stocks, meanwhile, fell to $4.95 per trade earlier this year at Fidelity Investments and Charles Schwab. And the startup Robinhood Financial LLC is trying to woo younger investors to its app-based brokerage platform with free stock trades—it makes money in part by selling premium accounts with after-hours trading and access to margin loans.
The race to zero is even more pronounced in the business of advice. There, Schwab has attracted $23 billion to its Intelligent Portfolios, an online service that creates a portfolio of ETFs for an investor at no charge, compared with the 1 percent per year many advisers can charge. Of course, for consumers, the proliferation of all this free and close-to-free stuff raises a question: Is cheap always a bargain?
It can mean accepting some limitations. Commission-free ETF trades are usually confined to a small group of funds, according to Alois Pirker, research director at Aite Group LLC’s wealth management practice. This isn’t necessarily a bad thing for investors who just want a basic, broadly diversified fund. “If it’s an S&P 500 ETF, it doesn’t matter who manufactures it, necessarily,” he says.
Behind a headline price tag of free, companies have ways of generating revenue from some products. The underlying ETFs in Schwab’s online advice service still have annual fees, and many of those funds are run by Schwab. A portfolio for an aggressive investor may have an average cost of 0.22 percent per year. Schwab also makes money when it allocates some of its clients’ money to cash, which it can then invest and profit from. Schwab rival Betterment LLC, whose online advice service costs 0.25 percent per year, has argued that this gives Schwab an incentive to put too much in cash. Schwab spokesman Michael Cianfrocca says cash can provide better returns than other low-risk alternatives, after accounting for their fees.
Over an asset base of billions of dollars, a few pennies here and there can add up for an asset manager. Still, the march toward free is putting many people in the financial-services business under pressure. Stock trading and portfolio allocation—once the main reasons people hired a broker—have been turned into ultracheap commodities. Advisers are looking for ways to avoid obsolescence, and selling more complex products is one of them.
You can see that most clearly in the part of the business aimed at wealthier individual investors—not the ones with family offices and Learjets, but those in the near-millionaire to mere-millionaire range. Private equity giant Blackstone Group LP has been courting advisers—more than 3,000 since 2012—as part of a program it calls Blackstone U. Participants have been flown to New York to visit its Midtown Manhattan high-rise offices, where they’re educated about alternative strategies, including private equity, real estate, and hedge funds. “They see the benefit of differentiation,” says Joseph Lohrer, national sales manager for Blackstone’s private wealth management group. “They say, ‘I can build better portfolios if I incorporate alternatives, but I feel that I am not in a confident position to make that happen, and this program allows me to take a huge jump in understanding and integrating alternatives.’”
For regulatory reasons, the average investor is locked out of many alternative investments. But Blackstone is looking for ways to push deeper into the mass affluent market. The company already has a mutual fund that allocates money to hedge fund managers, the Blackstone Alternative Multi-Strategy Fund. Part of the case for such investments is that they can offer investors diversification they weren’t getting before. In exchange, however, they also carry higher fees. Blackstone’s mutual fund, for example, costs more than 2 percent of assets per year.
Less-wealthy investors, too, are being pitched more complex strategies, such as smart-beta, which proposes to improve on indexing by tweaking the formula for weighting stocks—essentially automating a kind of active management. But costs are getting squeezed there as well: Goldman Sachs Asset Management offers a smart-beta ETF for 0.09 percent of assets per year. “No one really wants to go out there and offer their stuff for free, but all the money is really going in that direction,” says BI’s Balchunas. “It’s as if the ETF space is the battleground that’s maturing, and now they’re going to inch into active, quant, and beyond.”