Q24 – What is a No Transaction Fee program?

Also available as podcast (Episode #24)

Apple  |  Android  |  Spotify  |  Amazon

What is a No Transaction Fee program?

While there has been a general movement in the recent past to move to “$0” transaction fees, that generally has only applied to equity/ETF trades. In most instances, transaction charges still exist with (among other things) mutual funds. However, custodians often have “No Transaction Fee” (aka “NTF”) lists of mutual funds in which if/when one of those particular funds are traded, the transaction charge is in turn waived. There are a number of variables involved as to why a particular fund is perhaps available on such a list or not.

Found This Video Helpful?

Want to learn even more by better understanding what a transition to the RIA model might look like for your own practice?  I encourage you to schedule a Discovery call, and I’d be happy to begin that conversation with you.

Full Transcript:

What is a No Transaction Fee program? This is the Transition To RIA video series. It is question #24.

Hi, I’m Brad Wales with Transition To RIA where I help advisors understand everything there is to know about why and how to transition to the Registered Investment Advisor (“RIA”) model.

In today’s question, we’re going to dive deeper into, what are No Transaction Fee programs, commonly referred to as NTF programs. In the most recent video I did, number 23, I encourage you to go back and take a look at it, I talked about the differences between transaction-based pricing and asset-based pricing.

Our conversation today is going to primarily relate to transaction-based pricing. I’ll give a quick high-level overview of what that is if you haven’t yet seen the prior video. I encourage you to look at both of them because I think they’ll help you. I did do this standalone video on NTF programs because there’s a couple of nuances that I think are worth diving into.

So real quick, when you have your own RIA and you work with your custodian, in that (client’s) account, every time – let’s say you’re using transaction-based pricing arrangement with the client….again, video 23, I explained all of this – every time a transaction is performed, back in the day, a year-plus ago, every time a trade occurred, for the most part, equity, ETF, everything, there was a transaction charge that was assessed. It might have been with equities and ETFs, $6, $7, $8 per trade, so (for example) $7 per buy, $7 per sell, that sort of thing.

Now fast forward, the world changed in this past year. Now most custodians for that equity and ETF piece are at zero per trade. What a lot of people don’t realize though is when the news on that came out and said….”Hey, transaction prices have gone to zero,” that was with respect to equities and ETFs. Not all custodians went along with that, but a number of them did. Regardless, it did not really change anything as it relates to mutual funds, and to a degree ETFs if that custodian did not follow suit and go to zero on ETFs. I’m going to focus primarily on mutual funds on this video, as that transaction pricing still exists in mutual fund trades.

By default, if you were to buy or sell a mutual fund in a client’s account, there is in theory, by default, a transaction charge on that for each buy and each sell. However, the custodians have set it up that….”as long as you use one of the mutual funds on our NTF list, No Transaction Fee list, then there will be no transaction charge on that.”

So every time you do a buy or sell there will be no transaction charges. That’s an NTF list, that’s what we’re going to talk about here and how that works.

What you as an RIA would do is as you’re looking at custodians there’s a number of variables of why you might choose one custodian over another. That’s a large part of what I help advisors understand and think through. If you are an RIA, or will be an RIA, that plans to use mutual funds, you want to make sure….do you (custodian) have my mutual funds available, and are they on the NTF list?”

In that first part, I did a whole separate video on that as well. Just because a mutual fund exists out there doesn’t guarantee that your custodian actually has it available for you to use, with accounts held at that custodian. I encourage you to look at that video as well.

Let’s assume your funds are available. You also want to be cognizant of are they on the NTF list of funds? In the universe of mutual funds that are on platforms, generally the bulk are on these NTF lists. It’s not like of all the funds a custodian offers or makes available to you, that only 10% are on an NTF list. Generally it’s a majority of the funds that are on that NTF list.

As long as you’re using one of those funds, the transaction charge gets waived. So you might be thinking….”Okay, what’s the catch? Why would a custodian just waive this charge? There’s something more to it?”

It is important to consider how a custodian generates revenue because as your own RIA, you keep 100% of the advisory fee. There is no grid payout. There is no haircut or anything like that by the custodian. You keep 100%.

A custodian obviously has to generate revenue somehow, and I’ll do a separate video on all the ways they generate revenue. One of those ways is on transaction charges. So the question is….why would a custodian just agree to waive that charge on this NTF list? What’s the proverbial, catch?

There’s not really a catch, it’s an arrangement of how these things are set up. Custodians have gone out to mutual funds and said….“Mutual fund companies, we’ll make you a deal. If you pay us a couple of basis points on the assets that are held in your funds on our platform, in return, we will do a couple of things for you. We might perform certain record-keeping requirements that otherwise would have to be done by the mutual fund. We will put you on this NTF list and so the RIAs that use our platform might be more likely to use your fund over one that’s not on that NTF list.”

There are benefits involved and in return the mutual fund company has to pay – it’s usually in basis points – a number of basis points back to the custodian for that package of services that’s being provided.

It’s just something to be aware of that’s typical. Whether you’re in an RIA custodial relationship, that sort of thing is occurring. If you’re at a large traditional brokerage firm, that sort of thing is currently occurring. It actually won’t necessarily be something new that you’re not experiencing now. Whether you realize it’s happening or not, it’s across the industry, whether it’s broker-dealers or custodians with mutual fund companies. These NTF lists, this is pretty typical across the board of how these arrangements are set up.

A notable exception to this….I’ve referenced the bulk of mutual funds are on these lists. I didn’t say that they all are. There are a number of mutual funds that are not on these NTF lists. There could be a number of reasons that mutual fund company does not agree to pay these basis points. They might say….”I don’t care if I’m not on your NTF list,” or, “I’ll do my record-keeping on the shareholders of the fund ourselves, as opposed to you doing it.” There might be a couple of reasons they essentially balk at agreeing to participate in this NTF program, if you will.

Another thing you see, and this is what’s usually more the case when you come across funds (not on a NTF list)….as an example, extremely low-cost index funds are generally not on these NTF lists. The reason is pure math. If that index fund itself is only charging an expense ratio of, call it, four basis points, and from that four, the mutual fund itself has to cover all of its expenses to run that fund, and of course, they’re trying to generate some margin in there, some profit in there. There’s simply nothing left to share with a custodian or share with a broker or dealer. It’s just pure math.

While it’s great that those expense ratios are very low, when there’s not enough in that to then share with a custodian, the custodian in turn then can’t go and give a free transaction on that fund because otherwise, if they gave a free transaction on a particular mutual or index fund, and that fund family is not giving any basis points back to the custodian, the custodian is not making any money on that asset, on that mutual fund holding. A custodian needs to generate revenue to cover their costs, to reinvest in the platform, those sorts of things.

So be aware there are those circumstances that for a number of reasons, that a fund might not be on that list.

A couple of things of what this means to you and your clients. Number one, this is not a conflict at all for you as the RIA. As the RIA, you will receive none of this custodial revenue. Whether it’s a transaction charge that occurs to buy or sell the mutual fund, whether it’s on the NTF list – so there’s no transaction charge but there’s basis points being paid back to the custodian from the mutual fund company, as the RIA you will receive none of that. There is no conflict for you as far as the frequency you might buy or sell mutual funds or the reason you might use one fund over another because none of that revenue is being shared back with you.

It makes the RIA-custodial relationship very clean in that regard. As an RIA you can go to your clients and say….”The sole way, the only way I am paid Mr. & Mrs. Client is by the advisory fee that you pay me directly”, that (for example) 1% of assets, “From there, it doesn’t make any difference how much or little I trade in the account. It doesn’t make any difference what investment solutions we implement with you because no matter which of those variables are involved, I get paid on none of that. I only get paid on the fee you pay me to look out for your best interest.” It’s a very clean model and very powerful message to explain that to clients. So again, I did want to clarify, it’s not a conflict. As the RIA, you would receive none of that (the transaction charge or basis points).

Next up is a challenge that continues to evolve, the increase in the number of share classes within each mutual fund. There was a time, 15+ years ago that mutual fund share classes were very simple. It was primarily literally A, B, and C, and that was it. Now, any given mutual fund could have a dozen or more different share classes.

A lot of these NTF programs are not just….”is this particular fund family on the NTF list?” It’s….”is the particular fund within that fund family on the list?” And then it’s also….”is a particular share class within that?” There’s different share classes that have different expense ratios. There’s different capacity for that mutual fund as to whether they’re able or willing to share some of those basis points back to the custodian to make this NTF list available.

The takeaway with that, and this is a typical part of your due diligence on a custodian – it’s something I absolutely coach advisors on and happy to help walk you through this as well – is as you’re looking at custodians, and there’s a number of different options out there – pros and cons to each one – a typical thing you would do if you use mutual funds with clients is you go to that custodian ahead of time, and you say….”here are the mutual funds I use (not just the fund families, not just the funds, but the specific share classes) if I were to move my assets to you as custodian, will those be available to me?”

I did a whole separate video on that of don’t just assume they will all be available. There’s a couple variables in there you need to be aware of so I encourage you to check out that separate video on….will all of my current mutual funds I use be available with my new custodian?

So number one, you want to ask….”will they be available?” And then number two, you’d say….”and are they on the NTF list?”

Whether the answer is yes or no to the first part of that could be very meaningful for you because if you desire to keep using certain funds, and your custodian doesn’t make them available, that could be a problem. With the second step….”are they on the NTF list?”, I would challenge you to not be short-sighted with that answer if some are and some aren’t. That doesn’t necessarily mean you should disregard that custodian in general, because, among other things, every other custodian might be in that exact same boat. But also, the existence of certain transaction charges is only one variable in custodian selection. There is a lot that goes into that. Don’t get too concerned about are they on the NTF list or not. It is nonetheless helpful to know, because you might build entire models off of that.

So again, this really comes down to share class. Don’t just ask about the mutual fund, ask about the specific share classes. Which you could determine if you just look at the CUSIP of the funds you have and they can look those up.

The final thing is the benefit to clients. All other things being equal, if a client has to pay a transaction charge on a mutual fund buy or sell or doesn’t, clearly it’s better for the client to not pay on that. If the share class of a mutual fund that you were going to use is what you were already going to use with the client because you think it’s the best investment for them, it’s not like….“well, that same share class on some custodians that have an NTF list is a different expense ratio than that same share class on a different custodian that does or does not have it on the NTF list.”

If you are going to use that fund anyways, and use that share class anyways because it’s what’s best for the client….in the long term, even if there are transaction charges, in the long term these are very minor compared to what hopefully that investment does for the client in general. Nonetheless, something to be considering.

To the degree it simply works out that….”we use this fund (because we believe in it) and we can get it for no transaction fee,” that’s obviously a plus to the client. Go back to the prior video, number 23. I talk about transaction-based pricing versus asset-based pricing. There’s pros and cons to each. I would say though, if you only use NTF mutual funds, it is worthwhile considering….”I should use transaction-based pricing because I actually won’t have any transaction pricing because they’re all on this NTF list.”

At the beginning of this video I noted some custodians still charge transaction charges on ETFs, and generally, those custodians have a NTF-ETF list as well. The same sort of thing applies. The same concepts I’ve been discussing apply to ETFs as well. Most custodians have gone to zero pricing on ETFs though, so it’s less of a point.

Parting thoughts on this….who knows what the future brings? I don’t think a couple of years ago, a lot of people would have predicted that we’d be zero for equities and ETF trades. In most cases, I think a lot of people thought they would keep coming down (in price), but to go to zero?! The question is now, will there come a time that all mutual funds are zero transaction charges?

At face value, that would seem to be a good thing. The flip side is, if it does go to zero, a custodian needs to make that revenue up some other way. Maybe there is an implementation of an asset-based pricing charge instead. We get rid of all of these transaction charges, make them zero across the board. However, asset-based pricing is not the standard way (currently) these things are priced out by custodians. It’s hard to tell what the future will bring.

The last thing and just to repeat, this is an important topic to understand. It’s important to know how transaction charges work. It’s important to know when you can avoid them. They’re a lot less prevalent than they were just a year ago because a lot of these (custodians) have gone down to that zero pricing. That’s just one component though when deciding whether one custodian is better for you, because they might have slightly different pricing or how they price it out.

With all the variables involved (in custodian selection), that certainly should not be the sole decider you have of a custodian. It’s important to be aware of. It’s important to make sure they’re in the ballpark of each other, which generally they are. But there are a lot of variables that go into it and again, that’s a lot of what I help advisors with.

With that, like I said, I’m Brad Wales with Transition To RIA, where I help advisors, just like you understand everything there is to know about why and how to transition to the RIA model.

Like I was mentioning here today….what are the kind of questions you want to be asking a custodian as it relates to your specific business? If you don’t use mutual funds, you don’t need to be asking about mutual funds. You could, because maybe you want to use them in the future, but you want to know….what questions should I be asking? What answers should I expect to be hearing back? That’s the exact sort of thing I help advisors with to be fully informed before they begin some of those conversations. I’d be more than happy to have that conversation with you as well.

If you’re not already there, head on over to TransitionToRIA.com. You can see plenty more videos I’ve posted. I’ve mentioned some of them here on this video. I also have whitepapers on the economics of the RIA model. The easiest path is right there at the top is a contact link. Click on that. You can easily and instantly schedule a specific date and time that you and I can have a one-on-one conversation. Whether it’s about something very specific, like today’s topic, or more broad where you want to begin that conversation of….”Here’s my current practice, my current affiliation model and the current firm I’m with….what would that look like in the RIA model from an economics perspective, a responsibility perspective, a flexibility perspective? I am more than happy to have that conversation with you.

I hope you found value in today’s video, and I’ll see you on the next one.

Want To Learn More?

Schedule a Discovery call and lets begin a conversation.

Share this post

Read my free whitepaper!

Get instant access to my free whitepaper on "11 Ways The Economics Of The RIA Model Are Superior To Other Advisor Affiliation Options".
FREE WHITEPAPER:  “Steps To Take Now If You Anticipate Transitioning Your Practice To The RIA Model Anytime Within The Next 10 Years.”