Why industry fee compression is no act of altruism

Behavioural finance expert warns clients they must understand full cost of a fund despite the 'race to zero'

Why industry fee compression is no act of altruism

Advisors have been urged to remind clients that the best place to put their money is with a firm that “wins when they win”.

Vanguard’s recent decision to follow other peer brokerage firms in the US in eliminating stock commissions continued the industry trend ignited by Charles Schwab, which was the first major broker to give investors zero-commission online trades.

TD Ameritrade and ETrade quickly copied this move, with Fidelity following suit. In confirming the move, Vanguard said it expanded its commission-free platform, which has included mutual funds since 1977 and nearly every ETF since 2018.

Dan Egan, managing director of behavioural finance and investing at Betterment, told WP that while this is simply a continuation of the broad fee compression across the industry, Vanguard may face a different challenge, given their business model means they plough proceeds from stock lending back into their funds to the benefit of shareholders, rather than as a revenue source.

More pertinently, he also warned investors that these heavyweight firms aren’t racing to zero out of altruism.

“Broadly, the industry’s transition toward zero-fee ETFs means that investors will have to consider more aspects of a fund to understand its full costs,” he said. “It’s especially crucial for clients to understand how Vanguard, Schwab, and Fidelity are continuing to make money even as they’ve cut their most visible fees.”

He explained that brokerages make a profit when clients trade frequently and that they have become skilled at influencing client behaviour. Egan also warned about clients having their money moved into different in-house funds without informing customers.

He added: “Because offering free trading encourages your clients to trade much more frequently, they’re likely to take a dip in performance. Meanwhile, the brokerage firm will still generate consistent revenue through activities like selling order flow.

“It’s also likely that zero-fee funds may cause more conflicts of interest in investing—for example, last spring, SoFi was caught moving customers from existing investments into the company’s new ETF, increasing their tax bills. Now that commission-free has become the new normal across the industry, be sure to remind your clients that the best place to put their money is with a firm that wins when they win.”