Two Really Cheap ETFs Face Off. Investors Win.

Photograph by Gianluca Fabrizio Close

Photograph by Gianluca Fabrizio


Photograph by Gianluca Fabrizio

Charles Schwab (SCHW) made a huge splash last September when it slashed expense ratios on several of its exchange-traded funds. They included the Schwab U.S. Broad Market ETF (SCHB), which saw expenses cut from 0.06 percent to 0.04 percent -- or $4 per year for $10,000 invested. That made it the cheapest fund since the invention of the first mutual fund in 1924. With expenses now less than the cost of a small pizza, the fund has doubled in size to $2 billion, and is ever-so-slightly outpacing the S&P 500.

The ETF industry has been innovative in expanding where and how funds invest. The competition in cost is another frontier altogether. Vanguard started the low-cost trailblazing with its index mutual funds and then with its ETFs, but Schwab has taken it to another (lower) level. Whether Schwab is doing it to gain marketing attention or as a loss leader to get investors onto its platform (or a bit of both), the end result is cheaper ETFs, which is a good thing for investors.

The ETF lives up to its name by casting its net wide and holding 1,950 U.S. stocks, which comes out to 488 stocks per fee dollar -- one of the best bangs for a buck in ETF Land. The stocks cover all major sectors, with the heaviest weighting in financials at 17 percent and the lowest weighting in telecommunications services at 2.5 percent. About three-quarters of the holdings are large-cap stocks; 20 percent is in mid-caps and 7 percent in small-caps. The top 10 holdings make up 15 percent of the total, indicating that it is a very diverse ETF.

Liquidity Boost

Since its launch in November 2009, SCHB has lived in the shadow of its biggest rival, the Vanguard Total Stock Market ETF (VTI), a $31 billion ETF. It's a hair more expensive with a 0.05 percent fee, but offers broader coverage with its portfolio of 3,183 stocks. In a stock-per-dollar measurement, VTI is cheaper than its Schwab counterpart. Both have an annualized three-year return of 17 percent. While SCHB has nearly doubled in size since last September, VTI has hauled in $4.5 billion since then, an increase of 17 percent.

The true cost of an ETF is not limited to the expense ratio. In the case of SCHB, the increase in size has translated to an increase in liquidity -- it now trades 455,000 shares per day. That has helped tighten its bid-ask spread (the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept) to two cents. The other cost is the trading commission, which can run about $8 to $12. The ETF is free of charge on Schwab’s ETF One Source platform.

While SCHB is the broadest, cheapest ETF out there, it's worth noting that its sibling, the Schwab U.S. Large-Cap ETF (SCHX), also has a 0.04 percent expense ratio and has seen a $400 million, or 40 percent, increase in assets. SCHX focuses on large-caps and tracks 752 stocks.

Eric Balchunas is an exchange-traded fund analyst for Bloomberg. More ETF information is available here.

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