One reason Charles Schwab & Co. has been an SMI recommended broker for many years is the company’s large fund selection. Schwab offers about 7,500 no-load mutual funds.
More than 4,200 of those are "NTF" funds — they carry no transaction fee. The cost of buying any no-load fund that’s not on Schwab’s NTF list is $49.95.
At least that was the case until today. The $49.95 purchase-only transaction fee remains in place for most non-NTF funds. But retail investors who buy Vanguard, Dodge & Cox, or investor-class Fidelity funds via Schwab will pay more: $74.95. That’s 50% higher than what Schwab charges for online trades of other transaction-fee funds. (This same two-tier transaction-fee structure is also now in effect at TD Ameritrade, which is owned by Schwab.)
They won’t pay to play
Schwab says the reason behind the price increase is that those three fund families — Vanguard, Dodge & Cox, and Fidelity — refuse to pay the price Schwab demands to be on its platform.
"The majority of mutual fund families pay Schwab...for necessary and important shareholder servicing expenses, but some do not," a Schwab representative told Barron’s (paywall). "We are applying this different amount on retail mutual fund purchases only for funds for which we do not receive shareholder servicing compensation."
Schwab provides details about its various compensation models (at some length) on this web page, but here is the information relevant to today’s increase:
Most TF [transaction fee] Funds pay Schwab [an] annual asset-based fee, typically 0.10% annually of the average fund assets held at Schwab, although the fee can range up to 0.25% annually.... Some TF Funds pay Schwab a set dollar amount per customer account in lieu of the asset-based fee, typically $20 per account annually....
The transaction fee..., together with the asset-based or per position fees received from the funds, helps compensate Schwab for the shareholder services it provides to customers who own TF Fund shares.
Even though more than 130 of Vanguard’s traditional funds are available via Schwab, a Vanguard representative told Barron’s that the company "has a long-standing policy of not paying distribution fees that incentivize sales of our funds on third-party platforms." In other words, if investors want to buy Vanguard’s traditional funds without paying a fee, they should cut out the middleman and buy directly from Vanguard.
A Dodge & Cox spokesman made the same point: "Individual investors can invest directly with us without paying a transaction fee." Fidelity didn’t respond to Barron’s request for comment.
More to come?
For now, Schwab’s transaction-fee increase affects only funds offered by Vanguard, Dodge & Cox, and Fidelity. We’ll have to wait and see if this transaction-fee "surcharge" model spreads to other funds on the Schwab platform, or whether this is simply a one-off situation. (We should note that for several years now, Fidelity has charged a bigger fee for buying Vanguard and Schwab funds than it does for other transaction-fee funds.)
Retail investors have enjoyed a season of declining fund fees (of various types) for several years now. Let’s hope this latest move by Schwab isn’t the start of a trend reversal.
Impact on SMI investors
For SMI investors who invest with Schwab (or TDA), the impact of this latest pricing change should be minimal. One reason is that Schwab’s new pricing policy leaves ETF trades unaffected. Exchange-traded funds — including Vanguard and Fidelity ETFs — will continue to trade free via the Schwab/TDA platforms. So you may be able to use comparable ETFs instead of traditional mutual funds.
It is also worth noting that Schwab’s $49.95/74.95 fee isn’t applied in all cases, according to the company’s pricing guide. Schwab waives any transaction fees for trades that are less than $100. So, for example, if you were dollar-cost-averaging $75 a month into a transaction-fee fund at Schwab, you wouldn’t pay a transaction cost.
Further, Schwab’s transaction fees have a sliding scale. "[T]ransaction fees do not exceed 8.5% of principal," the company says on its website. To give an example, a $500 purchase of a transaction-fee fund would incur a transaction cost of $42.50, not the full fee of $49.95 charged for most funds or the $74.95 fee charged for Vanguard/Fidelity/Dodge & Cox funds.
Keep in mind, too, that Schwab offers many Schwab-brand traditional funds that are suitable substitutes for Vanguard and Fidelity funds. That means if you are considering a Vanguard or Fidelity fund that would incur a transaction cost, you may be able to find a comparable Schwab-managed traditional fund that carries no transaction fee.