Free is Good

IndexUninverse had a post about a new line of ETFs coming from a company called FocusShares that will include some broad index funds along with some sector funds and because the company is owned by Scottrade the funds will trade commission-free for Scottrade customers. Most of the proposed funds will seek to undercut competitors' funds on operating expense as well.

There is nothing new about free ETF trading or downward pressure on expense ratios other than we are now seeing more of this across the industry. I think it was Matt Hougan who first predicted there would be free ETF trading and it is looking more and more like he will be correct. This would obviously be a great thing for investors if happened. An investor with a $25,000 balance in his IRA would be able to capture as many narrow themes as he could follow with no commission drag; this perhaps being all the more important if broad indexing has another decade of poor results.

The proposed FocusShares funds;

* Focus Morningstar US Market Index ETF (FMU), 0.05% expense ratio
* Focus Morningstar Large Cap Index ETF (FLG), 0.05%
* Focus Morningstar Mid Cap Index ETF (FMM), 0.12%
* Focus Morningstar Small Cap Index ETF (FOS), 0.12%
* Focus Morningstar Basic Materials Index ETF (FBM), 0.19%
* Focus Morningstar Communications Services Index ETF (FCQ), 0.19%
* Focus Morningstar Consumer Cyclical Index ETF (FCL), 0.19%
* Focus Morningstar Consumer Defensive Index ETF (FCD), 0.19%
* Focus Morningstar Energy Index ETF (FEG), 0.19%
* Focus Morningstar Financial Services Index ETF (FFL), 0.19%
* Focus Morningstar Health Care Index ETF (FHC), 0.19%
* Focus Morningstar Industrials Index ETF (FIL), 0.19%
* Focus Morningstar Real Estate Index ETF (FRL), 0.12%
* Focus Morningstar Technology Index ETF (FTQ), 0.19%
* Focus Morningstar Utilities Index ETF (FUI), 0.19%

I'm not certain but I believe all of the sector funds are simple domestic exposure along the lines of the Sector SPDRs or the iShares sector funds. In that context there will be times (maybe all the time?) where domestic funds in this context are not the desired way to access sectors. In that case there might be foreign ETFs that will trade commission free but if not I would not go with what you believe to be an inferior way in to save a $9 commission or maybe two $9 commissions.

Using the materials sector as an example, the Focus Morningstar Basic Materials Index ETF may not be ideal, maybe something like iShares S&P Global Materials ETF (MXI) would be more suitable and commission free somewhere so you could buy that and get more precise exposure to what you think is the best way in to materials. MXI which is a client holding has a lot of exposure to foreign mining companies. If however, you think the best way to own the materials sector is with Yara International (YARIY) and Cementos Argos (CMTOY), to pick two stocks I've never owned, then you probably need to go ahead with the stocks as no free ETF will create the exposure for you; obviously I am talking about accounts above a certain size.

But if you can use free ETFs to build 85% of your portfolio and then buy three or four stocks for the rest then you're only spending $27-$36 to implement a potentially narrow based well thought out portfolio. What portfolio size is $36 not too large of a commission drag? That depends on the end user but I think it is obvious that this serves to be a democratizing force for anyone inclined to spend the time but not yet with a sizable account balance.