The latest investing trend: not just low-fee but no-fee

A David and a Goliath have shaken up the investment industry this month with new investment products that take the growing trend of low-fee investing one step furtherand charge no fees at all.

Major money manager Fidelity Investments announced last week that it would offer two mutual funds with a management expense ratio of zero meaning the funds are free to own, and don't eat away at investors' returns with behind-the-scenes investmentfees.

The two fundsannounced last week one which invests in American companies, the other in global stocks were a giant leap foran investment world that has been slowly inchingtoward lower fees for years.

So-called index funds which seek to replicate broad market returns instead of wasting money and effort trying to beat them have exploded in popularity in recent years, and competition among them has led tolower fees across the industry. Most mutual funds and exchange-traded funds (ETFs)alsonow have fees that are significantly smaller than what they used to be in many cases, fractions of a penny foreverydollar invested.

Fidelity moved first with free funds, but then on Thursday Toronto-based money manager Wealthsimpleplayed a gambit of its own on the trading side, announcing what isessentially a self-service online stock brokerage.

Wealthsimple Trade will allow users tobuy, sell and track stocks and ETFsthrough an app, free of charge, without having to maintain a minimum balanceor execute a minimum number of trades every quarter.

Right now, all of Canada's big banks, along with a handful of others, offer customers the ability to buy and sell stocks for fees of up to $9.99 per transaction. Fees can sometimes be lower for active tradersorthose investing large sums.

But no one has previously offered free trading with no apparentstrings attached.

"We're able to offer commission-free trades because we've built a low-cost, digital-first brokerage powered by technology," the company says in aFAQ explaining the deal. "And executing trades actually costs very little for brokerages, so we don't think it's fair to charge our clients big trading commissions."

'How are they making money?'

For money coach and certified financial plannerNoel D'Souza, anytime investors see their fees go down, it's something to be celebrated. But the word "free" gives him pause.

"The trend toward low fee is definitely good," D'Souzasays, "but once we hit zero, my question is: How are they making money? Andare they making that clear to their clients?"

Financial planner Rona Birenbaumagrees thatFidelity's plan hinges on making uplost revenue elsewhere."Nobody who is a for-profit business will offer something for free if there is no profit potential in it," she said "So really what it means is there's a fee or there's a cost or some kind of compensation model somewhere else."

Personal finance commentator PreetBanerjeesays one way Fidelity is likely planning to recoup costs is to loan out the fund's shares to short sellers. Read thisfor a detailed look at how it works, but essentially short sellers make money by betting against certain companies. They do this by borrowing shares in them, selling them, and then buying the shares back at a lower price later to replace the borrowed share they sold. (Their profit is the gap between the two prices.)

Investors who loan out shares to short sellers typically charge interest to do so, which could be part of how Fidelity plans to eke out a profit.

"You can actually make, in some cases, more money than you are charging in terms of the management fee," Banerjee says,"so it's still possible to generate revenue even though the management fee might be zero."

It's why he thinks its possible the world could soon see a fund with a fee of less than zero one that pays you to own it.

A huge, multifaceted company like Fidelity can probably offer no-fee funds because it has myriad other ways of making money once it has enticed someone in the door sellingthem other funds or investment products, for instance, to recoupincremental losses incurred on its free offerings.

Fidelity may well have plenty of other imaginative avenues for making money while it cuts its fund owners a break. But Wealthsimple's basic business is offering simple, managed portfolios to novice investors at rock-bottom prices. The company currently manages about $2.5 billion in assets, spread across 100,000 customers in Canada, the U.S. and the U.K.

If what you're buying or what you're getting is free, then you're the product.- Rona Birenbaum

It may not have the heft of Fidelity, but Banerjee says Wealthsimple'splan is also a shrewd way of bringing in new customers at a marginal cost.

"There will be some clients [who will just]buy and hold a few stocks and not pay any fees, but there will be other people that will take advantage of other service offerings," like trading with borrowed money, known as margin, or trading in investmentsknown as stock options both services the company could easily charge a money-making feefor.

Wealthsimple's offering is still in the planning phase, so it's unclear exactly what it will look like, but in terms of simple stock trading, the company saysthere's no catch no chargeto buy and sell thousands of equities.

It says it willcharge to convert currencies and mentions other "premium features" to come in the future, which will likely have fees attached. But the company says it will "publish a clear pricing and fee schedule before the product is available."

Banerjee says one of the risks he sees with the plan is that Wealthsimpleclients might take too much advantage of the free feature and shoot themselves in the foot over the long run.

"Some people are going to be attracted to trading more often and trading too much," he says, "and end up hurting more than the cost that [they're]saving."

Birenbaumgives the same warning about these products as she would about anything claiming to be a free lunch.

"If what you're buying or what you're getting is free," she says,"then you're the product."

With files from the CBC's Shawn Benjamin