$0 stock commissions are another nail in the coffin of mutual funds and ETFs
This is a spooky time… for ETFs and mutual funds. Schwab recently made headlines by reducing its commissions to $0. Most of the major custodians followed suit. This obviously saves investors money. Less obviously, it brings us one step closer to the death of mutual funds and ETFs.
Mutual funds and ETFs are just wrappers for delivering investment portfolios. Investors buy the funds, which buy securities. What’s the alternative? The investors bypass the middleman and just own the underlying securities themselves. This allows for more customization, and it’s much more tax efficient. (We’ve written about the advantages of direct security ownership before. See Why Not Direct Indexes and Direct Indexes are Better than ETFs.)
Rebalancing automation systems (like ours) have tackled the problem of managing these direct-security-ownership accounts at scale. That has left just two barriers standing in the way of the demise of the mutual fund, at least for liquid asset classes: 1) per share commissions, which make it uneconomic for small accounts to buy all the underlying shares and 2) whole-share trading, which makes it infeasible for small accounts to buy the amount they need of each security.
With Schwab’s recent $0 commissions, the first of these barriers has now come down. That just leaves whole-share trading. Fractional-share trading is already supported by custodians like Apex Clearing, FolioFn and DriveWealth. And there are rumors that some of the major custodians are not far behind.
If investors can buy equities in fractional shares and pay $0 commissions, mutual funds and ETFs become 2nd best solutions, at least for liquid asset classes. Does this really mean mutual funds and ETFs are dead? Probably not. They’re still useful for illiquid asset classes, and ETFs are still useful for traders looking for extreme liquidity. But, if not dead, mutual funds and ETFs are very much under threat (and we’re not the only ones to think this — one mutual fund executive told us, point blank, “mutual funds are” — wait for it — “dead”). It will start slowly, but be on the lookout for more and more separately managed accounts, direct indexes especially, that are priced competitively with ETFs. We expect a trickle will turn into a flood...