Buying (and Selling) Convenience
Five years ago, Charles Schwab & Co. came up with a quirky idea: to allow investors to buy and sell no-load mutual funds in a brokerage account without paying any transaction fees.
Skeptics weren’t sure the idea would fly. Investors already could purchase commission-free funds through the mail and over the phone. Would they bother to link up with a brokerage simply for the convenience of being able to do it all in a single account?
The answer has been a resounding yes.
Since launching its trailblazing no-fee program in the summer of 1992 with 80 mutual funds from eight families, Schwab has added 990 more funds from 92 additional groups. Assets in the no-load no-brokerage-fee program now top $53 billion.
Perhaps more telling, Schwab’s innovation has spawned plenty of competition among what are commonly called fund supermarkets.
At least 64 other discount brokerages now offer no-load mutual funds, according to a January 1997 survey by the Chicago-based American Assn. of Individual Investors. In a study released last month, the group identified 24 of those brokerages as offering funds with no transaction fees. The second-largest such firm, Fidelity Investments, counts $20 billion in assets in its no-load no-fee program.
The idea of supermarkets has spread to traditional brokerages, some of which now offer dozens of load and no-load fund families, often through “wrap accounts” that charge annual advisory fees. (See accompanying story.)
There are, to be sure, certain drawbacks to these programs. But an ever-greater number of investors like that they can cherry-pick funds from several families and hold them in a single account, that they get a single monthly statement, and that their tax records are fewer and more consistent.
These kinds of accounts also make it easy to switch money among funds in different families. By dealing with a brokerage, you don’t have to open an account at each fund group with whom you want to invest; nor do you have to close an account for each redemption. When you want to place an order, there’s only one phone number to call. This not only saves time, but also may allow you to skirt the account-closing fees that some firms impose, especially on individual retirement accounts.
The convenience factor has proved to be a powerful lure for investors such as Tad Stock, a retired structural engineer who lives in Diamond Bar.
“I had to have a place to put an IRA” being rolled over, he said. “I wanted a location that provided a lot of investment choices without having to break up the IRA.”
Stock’s portfolio of no-load holdings, held in a Fidelity brokerage account, includes funds from the American Century, Lexington, Oakmark and Rydex families. He particularly likes being able to switch funds easily and having all transactions listed on a single statement.
Participating in the no-fee brokerage programs can also help you skirt certain duplicative fees. Discount brokerages generally don’t, for example, impose yearly IRA fees for accounts with assets above $10,000 or so. Individual fund companies generally do impose such fees, however, and that can really add up if you have small-dollar balances at several firms.
Research help is another advantage. Many brokerages provide performance data and other important facts about mutual funds, both in printed form and over the Internet. Carmen Dimperio, a Phoenix retiree and Charles Schwab customer, says he routinely scrutinizes Schwab’s performance update each quarter.
As good as these supermarket programs are, though, they aren’t perfect.
For starters, even the discount programs aren’t necessarily free. Indeed, many of the no-load funds offered by discount brokerages don’t qualify for no-fee treatment. Rather, investors face a charge ranging from roughly $20 to $45 per transaction, depending on the firm. And on some of the no-fee funds, depending on the firm, you might face a modest redemption charge if you sell out within three to six months or so.
For the convenience and other benefits of trading through a brokerage, you may certainly find that the flat trading fees are justifiable, especially if you have substantial assets in the account.
Stock and Dimperio, for instance, hold a few funds for which they paid a transaction charge in addition to their no-fee holdings.
“With the amount of money that I’m trading, Fidelity’s $35 transaction charge is inconsequential,” Stock says.
Discount brokerages also sell load funds, for which the normal sales charges apply.
In addition, there’s some evidence that supermarket participation may indirectly raise fund costs to everyone owning those funds.
Research firm Morningstar Inc. of Chicago found that the average yearly expenses of funds in Fidelity’s and Schwab’s programs came to 1.37% and 1.3%, respectively. By comparison, funds not included in these programs charge 1.08% on average. Vanguard, T. Rowe Price and USAA are among the families that don’t allow their funds to be traded in competitors’ no-fee programs.
“The costs of supermarket distribution don’t show up on any statements, but they do appear to be built into the expense ratios of participating funds,” Morningstar says in a report. “On average, supermarket funds just cost more than old-fashioned independent no-loads.”
These higher expenses are borne by all of a fund’s shareholders, not just those who invest through a brokerage. The implication is that you should either avoid these choices or buy them through a supermarket.
“If you’re thinking about buying a fund from Berger, Janus or Montgomery, make sure you buy it through a mutual fund supermarket,” Morningstar suggests. “You might as well get everything you’re paying for.”
Participating mutual funds pay brokerages 0.25% to 0.35% a year to be included in the no-fee programs, equal to $2.50 to $3.50 for each $1,000 investment.
For that fee, though, participating funds do receive various benefits, so it’s hard to gauge what the true cost to them is. In addition to providing greater market exposure, the brokerages open and close accounts and handle other administrative tasks for the funds.
“The fees are very defensible because we’re handling shareholder calls, mailing statements to customers and absorbing a lot of the expenses of dealing with investors,” says Robert Mazzarella, president of Fidelity’s brokerage arm.
L. Roy Papp, head of a small fund group in Phoenix that bears his name, agrees. He estimates that the true cost for his funds to participate in supermarket programs is only 0.15% to 0.20%. And that doesn’t take into account the extra marketing exposure that fund families receive--a benefit that’s difficult to quantify.
Another criticism is that the supermarket programs encourage people to trade excessively, since it’s less expensive and time-consuming for them to do so. Not only can such trading hurt an investor’s own performance, it also raises costs for other shareholders in a fund, says John Bogle, founder and senior chairman of the Vanguard Group. He refers to the supermarkets as “mutual fund casinos.”
Vanguard’s own discount brokerage arm doesn’t allow no-fee trading on the roughly 400 non-Vanguard funds available through the program.
“We feel our charge of $35 per transaction is reasonable,” says Jim Gately, a Vanguard managing director. The fee “makes people think twice before trading.”
Whatever the critics’ arguments, however, investors are sold on the supermarkets, which are continuing to grow rapidly. They offer convenience and simplicity in an increasingly complex financial world.
Russ Wiles is a mutual fund columnist for The Times. He can be reached at russ.wiles@pni.com
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Tips for Supermarket Shopping
* If you like to trade funds, look for a broad selection of investments and brokerages that allow you to trade many funds with minimal charges.
* Beware of redemption charges. To discourage short-term traders, many supermarkets impose fees on funds held fewer than three to six months.
* Consider operating hours. Larger firms operate around the clock, but others shut down as early as 2 p.m. Pacific time and have no weekend hours.
* Compare fees and services. Ask about discounts for electronic trading. Full-service brokers, online brokerages and mutual fund companies are now competing with discount brokerages.
* Ask about research services. You often can receive performance numbers and research reports on individual funds through some discount brokerages, along with published guides and online calculators.
Researched by Russ Wiles / For The Times
