RIAs and the ETF phenominon

ETF, or “Exchange Traded Funds” have exploded in popularity over the last few years. RIA advised brokerage accounts are one of the reasons for this ETF boom.

Why would an RIA recommend an ETF over a traditional mutual fund?

One of the primary reasons is that ETF funds cost almost nothing (sales charge) to buy through a client’s custodian brokerage firm. Typical discount brokerage commissions to buy an ETF are $9.99 per trade regardless of the size of the trade. This can represent an enormous cost savings when compared to the cost of buying a traditional mutual fund. Traditional mutual funds may charge upfront sales charges to buy their funds. Further, the internal charges of an ETF are typically a fraction of the internal charges of a traditional mutual fund. All other factors being equal, an RIA will recommend the lower cost product because the RIA has NO commission incentive to do otherwise.

On the other hand, the investment advice given by a full service Stockbroker may be for you to buy the higher cost mutual fund because the full service Stockbroker can collect a commission on your purchase of the mutual fund. Further, the full service Stockbroker may participate in the higher ongoing internal fees that the mutual fund charges.

The question to a full service Stockbroker recommending that you buy a mutual fund should be:

1. “Do you receive any sales compensation if I buy this mutual fund?”

2. “Will you receive a residual commission from this mutual fund if I buy this mutual fund?”

The answer to both of these questions would typically be YES if you are receiving the investment advice from a full service Stockbroker.

The answer would LEGALLY be NO if the advice came from an RIA. (The custodian brokerage firm will however typically collect their $9.99 for the initial trade. Further, the custodian brokerage firm will collect any residual commissions if the mutual fund pays/charges residual commissions.)

Again, an RIA cannot collect any upfront mutual fund sales charges, or commissions, nor can an RIA collect any ongoing mutual fund residual commissions. As such, an RIA will typically steer you in the direction of the low cost product or fund (such as ETFs), and typically the fund choice NOT charging/paying any residual commissions (all other things being equal). Initial commissions and ongoing residual commissions can have a compounded NEGATIVE affect on the investment performance of any mutual fund. All other factors being equal, clearly you want to be advised to buy the lowest cost product. The longer your investment time horizon, the more dramatic this negative cost compounding affect of fees becomes.

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RIAs and the ETF phenominon ETF, or “Exchange Traded Funds” have exploded in popularity over the last few years. RIA advised brokerage accounts are one of the reasons for this ETF boom. Why would an RIA recommend an ETF over a traditional mutual fund? One of the primary reasons is that ETF funds cost almost nothing (sales charge) to buy through a client’s custodian brokerage firm. Typical discount brokerage commissions to buy an ETF are $9.99 per trade regardless of the size of the trade. This can represent an enormous cost savings when compared to the cost of buying a traditional mutual fund. Traditional mutual funds may charge upfront sales charges to buy their funds. Further, the internal charges of an ETF are typically a fraction of the internal charges of a traditional mutual fund. All other factors being equal, an RIA will recommend the lower cost product because the RIA has NO commission incentive to do otherwise. On the other hand, the investment advice given by a full service Stockbroker may be for you to buy the higher cost mutual fund because the full service Stockbroker can collect a commission on your purchase of the mutual fund. Further, the full service Stockbroker may participate in the higher ongoing internal fees that the mutual fund charges. The question to a full service Stockbroker recommending that you buy a mutual fund should be: 1. “Do you receive any sales compensation if I buy this mutual fund?” 2. “Will you receive a residual commission from this mutual fund if I buy this mutual fund?” The answer to both of these questions would typically be YES if you are receiving the investment advice from a full service Stockbroker. The answer would LEGALLY be NO if the advice came from an RIA. (The custodian brokerage firm will however typically collect their $9.99 for the initial trade. Further, the custodian brokerage firm will collect any residual commissions if the mutual fund pays/charges residual commissions.) Again, an RIA cannot collect any upfront mutual fund sales charges, or commissions, nor can an RIA collect any ongoing mutual fund residual commissions. As such, an RIA will typically steer you in the direction of the low cost product or fund (such as ETFs), and typically the fund choice NOT charging/paying any residual commissions (all other things being equal). Initial commissions and ongoing residual commissions can have a compounded NEGATIVE affect on the investment performance of any mutual fund. All other factors being equal, clearly you want to be advised to buy the lowest cost product. The longer your investment time horizon, the more dramatic this negative cost compounding affect of fees becomes. HOME