Cheap ETFs provide an almost free lunch

Matt Hougan at IndexUniverse has been doing a series of posts on the continuing decline in ETF expenses. In these posts he calculates the cost to a broadly diversified ETF portfolio using the lowest cost funds in each category. Back in March 2012 this portfolio had all-in costs of 0.112%. Not too shabby. After today’s announcement by Charles Schwab ($SCHW) that they were again slashing the fees on their in-house line of broad-based ETFs this portfolio, but our quick calculation, now has an all-in cost of 0.0865%. This portfolio consists of all Schwab ETFs except for the commodity component.

I don’t know about you but I find this development astounding. Not all that long ago these types of expenses were reserved for the largest institutional investor. Now they are available to the smallest investor. As a bonus Schwab customers can trade these ETFs commission free as well.* I thought this development of ultra low cost ETFs was important enough to devote a chapter of my book to the topic. If anything this development highlights the fact broad-based, asset class exposure via ETFs is for all intents and purposes free. Schwab is now offering broad US equity and US fixed income exposure at 0.04% and 0.05% per annum. One could easily just round down to 0.00%.

A number of months ago I wrote a post about why there has never been a better time to be an individual investor. This downward trend in ETF expenses reinforces this argument. Incumbent money managers are going to push back against this trend by introducing actively managed ETFs. Most investors can simply ignore this ploy and focus on fact that these firms are offering to manage your money essentially for free. There ain’t no such thing as a free lunch in this world, but at least when it comes to a certain class of ETFs there are some very cheap lunches.

*Most major brokerage firms have some sort of no-commission ETF trading program.

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