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Schwab Brings a Game Changer to the Market, Part I

by Richard

spider.jpgCharles Schwab and Co has dropped a bombshell into the crowded ETF (Exchange Traded Fund) marketplace.

So, it looks like the price war that started with books and DVDs this fall has now, finally, come to Wall Street.

First, some background.

State Street brought the first ETF to market in 1993.  SPY.  The “spider”, so-called, allowed investors to plunk down their money into an index fund, much like the legendary Vanguard 500 index fund that started the movement away from managed money in 1976.

But unlike the Vanguard fund, SPY could be bought and sold just like a stock, with no mandatory holding period or minimum purchase requirement, unlike traditional mutual funds.  Further, this hybrid security could be purchased on margin, and sold short….again, just like any other stock.

For long term investors, this is a mixed blessing at best.

Anything that allows a skittish investor to pull the trigger whenever the mood strikes can work against the long term trend towards higher valuations and regular compounding.

But it was a godsend to day traders and the new generation of high speed trading hedge funds…not to mention the brokers who get their ticket punched on every buy and sell order.

The other clear advantage of the ETF concept is the clarity that comes from transparency.

You can play your hunch regarding either broad market indexes, or finely sliced, and sometimes exotically esoteric, and micro granular sub-markets.

You go into the trade with your eyes wide open, and know exactly the mix and composition of stocks that comprise the index.

This way, you don’t bet the ranch on a specific stock.  Even in high flying sectors, there are always going to be one or two laggards,  sitting out there, exposed, two or three standard deviations from the bulge in the bell shaped curve of normal distributions.

This market is pretty much owned by I-Shares, State Street, and Vanguard.

Vanguard was late to the party, but quickly gained share due to their rock bottom management fees.

The advantage of investing in the larger and more liquid ETFs is that the spreads between bid and ask prices are narrower—-i.e. the pricing is much more efficient and fair.

Since the eight funds that Schwab is bringing to the market are broad based, me-too indexes that have ready, virtually identical,  counterparts offered by the three dominant  providers, they had to do something radically different to stand apart in the crowd.

This they accomplished by eliminating the commission on all trades in their new, proprietary ETF family…

…so long as the purchase is made online from a Schwab account.

This may not sound like such a big deal, when commissions now go as low as $7 per trade…but you’d be amazed at how fast these small sums pile up…especially among the hair trigger investors who consider the stretch between the opening and closing bell to be their long term investment horizon.

In our next posts,we will take a closer look at the new funds, which span both domestic and international broad market indices.

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