The High Cost of No-Transaction-Fee Platforms

For several years now the largest brokerage firms have been developing and marketing No-Transaction-Fee (or NTF) platforms for buying and selling mutual funds.  Charles Schwab, TD Ameritrade, Fidelity, Pershing, Raymond James and others have created mutual fund supermarkets where it is “free” for their customers to buy mutual funds.  Previously the cost to buy mutual funds on these platforms was anywhere from $30 to $75.

Unfortunately, these platforms masquerade as “free” while hiding the true cost of the waived transaction fee from investors.  It has been fairly well documented (here, here and here, for starters) that the brokerage supermarkets are charging mutual fund shareholders 0.30% – 0.40% to be part of the NTF platform.  That’s at least twice the cost of a typical Vanguard index fund.

What’s more, is that the brokerage houses demand these fees only, of course, for the assets housed at the firm.  However, unless each mutual fund creates a “Schwab” share class or a “TD Ameritrade” share class, the cost of this 0.30-.40% is born by all shareholders of the fund, not simply those with the brokerage firm in question.  So if you own a T. Rowe Price position directly at the fund, you are paying part of the 0.30-0.40%.

NTF platforms can also lead to poor investor behavior.  With no direct cost to buy or sell the fund, NTF platforms encourage high turnover in funds included in the platform, and also encourage performance chasing.  Again we can see how NTF platforms can have an impact on shareholders not participating in the platform themselves.  Performance chasing can lead to record fund flows, which are frequently very difficult to manage, leading to high cash positions in the fund and performance often suffers as a result.  High fund turnover can mean higher internal trading costs, less tax-efficient management and higher cash balances inside the fund to be able to manage redemptions.

While these transaction-fee-free platforms can be attractive on the surface to retail investors, it is important to understand the costs behind them borne by all shareholders. Investors should stay focused on their overall costs of investing: transaction costs, expense ratios, 12(b)-1 fees, advisory fees and taxes.

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