So you have settled on an asset allocation plan and have chosen your first mutual fund. For our purposes, we’ll assume you are going to invest in Vanguard’s S&P 500 Index Fund (VFINX), but the specific mutual fund doesn’t usually change how we’d go about buying it. Now you have two options: (1) buy shares of the fund directly from the mutual fund company (in our example, Vanguard); or (2) buy shares of the fund from an online broker like E*Trade or Zecco. So how do you decide?
Mutual Fund Company vs. Online Discount Broker
Opening an account: The process of opening an account and buying shares of the mutual fund are basically the same for both mutual fund companies and online brokers:
- Sign up for a new account online: The online application process for a company like Vanguard or an online broker is very similar. For both you’ll obviously provide basic information such as your name, address and telephone number, and you will of course need to provide your social security number and set up a user name and password. With the online security used today, you also will have to create answers to several security questions (e.g., What was the name of the elementary school you attended?)
- Link a checking or savings account: The most common way to transfer money to a mutual fund company or online broker is through direct transfers from a linked checking or savings account. To set this up, you’ll need your account number and routing transit number (RTN). The RTN is a nine digit number that appears at the bottom of checks next to the account number, and it identifies the financial institution the check is drawn from. Here’s what it looks like:
Note: You can also transfer money the old fashioned way, by mailing a check. But using checks is slow and inconvenient. You can also set up automatic contributions through transfers from your checking account or direct deposits from your employer.
- Buy shares of the mutual fund: It usually takes a couple of business days to get your checking account linked to your online broker or mutual fund company account and the funds transferred. Once that is complete, you can go to the mutual fund company or online broker’s website and execute the trade.
Cost: The cost of buying shares of a mutual fund is often the deciding factor in whether to buy directly from the mutual fund company or an online broker. Putting aside front end loads (and why would you ever buy a load fund?), there is generally no cost to buying shares of a mutual fund directly from the mutual fund company. In the case of Vanguard’s S&P 500 fund, there are no purchase or redemption fees. Vanguard does charge a $20 annual account maintenance fee, but will waive it if you sign up for account access on Vanguard.com and choose electronic delivery of statements, confirmations, fund reports, and prospectuses.
With online brokers, you will have to pay a fee for each trade you execute, although the fees are low. For example, Zecco, the home of $0 trades, currently charges $10 for each purchase of mutual fund shares. Zecco’s $0 trades for stocks does not apply to shares of mutual funds. E*Trade charges $19.99 per trade of mutual fund shares, although they do offer some mutual funds (not Vanguard) at no commission.
So why would you ever buy shares of a mutual fund through an online broker? Convenience.
Convenience: If you plan to invest in shares of mutual funds from several different mutual fund companies, using an online broker allows you to keep your investments in one place. And if you plan to invest in individual stocks or ETFs, the case for using an online broker is even stronger. Mutual fund companies like Vanguard over brokerage services where you can buy shares of non-Vanguard funds, individual stocks, or non-Vanguard ETFs, but the cost of these trades is generally more expensive than an online discount broker.
So what’s the bottom line?
If you plan to make monthly investments in the mutual fund, I would go directly through the mutual fund company. While the minimum purchase of Vanguard’s S&P 500 fund is $3,000, additional purchases can be as little as $100. Buying $100 worth of a mutual fund each month through an online broker is too costly.
On the other hand, if you are making a lump sum purchase and plan on investing in other stocks, ETFs or mutual funds offered by different companies, an online broker is probably the best choice.
Finally, you can do both. I have a Vanguard account through which I purchased several Vanguard funds. I also have a Scottrade account I use for my SEP IRA.