ETF is an abbreviation for “exchange-traded fund.” These funds can be traded on the market and often track different indexes and sectors.
Vanguard’s VOO, for example, is an ETF that tracks the S&P 500 index. ARKQ, on the other hand, is an ETF that tracks the tech and robotic sector.
ETFs can be used across all types of investment accounts; individual retirement accounts (IRAs), brokerage and variable annuities, and even some bank and trust accounts.
Although the personal finance community tends to recommend ETFs for their long term growth and low costs, there are a few different types of fees you should understand before investing in an ETF.
Of all the fees, operating fees, commission fees, and turnover fees are the most common.
Let’s break each one down so you can be more an informed investor!
Operating Fees (Expense Ratio)
The ETF expense ratio is an annual fee that ETFs charge investors to manage the fund. The ratio includes marketing, bookkeeping, legal work, management fees and other costs associated with ETFs.
To calculate the ratio, you use the following formula –
Operating Expenses / Average Dollar Value of a Fund’s Assets Under Management
Knowing a fund’s expense ratio is important because your investment return is directly affected by it.
Normally, ETF investors can expect an expense ratio of anywhere from .05% – 1.5%.
Although the expense ratio does note solely determine your investment outcome, keep in mind that ETFs with high expense ratios can take away from your investment return.
Commission Fees
A trade commission is the per-trade fee that brokerage firms charge ETF investors.
If a firm charges you $6.95 to execute a trade on an over-the-market ETF, this would be considered a trade commission.
These days, many brokerage firms offer commission-free ETFs. This means selective ETFs can be traded without applying a commission fee.
The popularity of commission-free ETFs might lead some investors to believe that ETF commission fees are no longer relevant.
- Some brokerage firms offer their own ETFs commission-free, while still charging a commission to purchase a competitor’s funds. Schwab, for example, states that only listed funds are subject to zero commissions. Unlisted funds are subject to commissions.
- Some ETF issuers form an agreement with brokerage firms in which the firm offers the ETF commission-free while passing on distribution fees to the investors.
- Some brokerage firms limit the number of commission-free trades you can have per month.
Knowing the cost of commissions will allow you to better understand what proportion of your return is going towards paying for this fee.
With this fee in mind, you can compare the total and percentage costs of ETFs.
Turnover Fees
Turnover is the rate at which shares within a fund are bought and sold over a period of time.
For perspective, the median turnover ratio for an ETF is 25%. This means approximately 25% of the fund’s shares were sold during the year.
When a fund frequently sells shares to buy new ones, the turnover ratio increases. Not only that, each turnover transaction incurs additional operating and trading fees.
Not only are additional fees incurred, capital gains from sale proceeds are subject to taxes that are passed onto the investor.
These additional fees and taxes can eat into your return and limit the investment earnings you are able to pocket.
While a passive, index-based ETF will tend to experience a low portfolio turnover, a fund that utilizes futures or bonds with regular maturity dates might exceed the median.
The Investment and Wealth Institute provides the following insight on turnover costs:
“High turnover can be spotted by taking a closer look at the Net Asset Value (NAV) of an ETF. Since the trading costs associated with high turnover will tend to weigh on a fund’s NAV, an ETF with high turnover may not track its underlying index as closely as expected.
High turnovers do not necessarily preclude an ETF from performing well—some ETFs with high-turnover strategies can achieve solid performance in spite of the higher trading costs incurred.”
ETF Fees vs. Mutual Fund Fees
Merriam-Webster defines a mutual fund as –
“an open-end investment company that invests money of its shareholders in a usually diversified group of securities of other corporations.”
With actively-managed mutual funds, the goal is to invest money in a diversified group of securities to outperform the market.
Differently, ETFs and index mutual funds aim to follow a specific market index (such as the S&P 500) or sector.
Mutual fund fees include management fees and other costs to cover fund oversight.
Fidelity explains mutual fund and ETF fees as such –
“Mutual funds charge their shareholders for everything that goes on inside the fund, such as transaction fees, distribution charges, and transfer-agent costs.
In addition, they pass along their capital gains tax bill on an annual basis.
These costs decrease the shareholder’s return on their investment.
On top of that, many funds charge a sales load for allowing you the pleasure of investing with them.
On the other hand, ETFs offer more trading flexibility, generally provide more transparency, and are more tax efficient than mutual funds.”
While Fidelity is clearly biased towards ETF fees, investors should know that ETF fees can add up as well.
In his book Index Funds and ETFs, David Schneider shares the following regarding index funds held in various accounts –
“Maintaining accounts for keeping your index funds might also cost you.
Your index fund itself might charge you only the expense ratio as indicated in their sales prospectus, but you still would need to pay your annual dues for holding those funds in separate accounts and all those third-party services that you can read up on in the small print of your fund advisory contract.
There are fees for account services, purchase and redemption fees, and other transaction costs that could accumulate.
Some less morally inclined index fund providers have even sneaked in fee structures that mirror those of actively managed funds.”
The lesson here is, before you invest, review the fees for yourself to determine the best return on investment.
Where to Find ETF Fees
According to the Security and Exchange Commission’s (SEC) disclosure requirements, certain fees – including certain commissions, management fees and transaction fees – must be listed in a fund’s prospectus.
A prospectus is a statement filed with the SEC that discloses the details about the fund.
In each prospectus, a fee table is required to disclose the fees and expenses that you may pay if you buy, hold, and sell shares of the fund.
This fee table is not required to list all brokerage fees. For example, fees to financial intermediaries are not always required to be listed.
To find these other fees, considering look through –
- The ETF’s website,
- Morningstar,
- The brokerage fee summary, and
- Other market data providers and tools.
It is also helpful to know that some sites let you compare ETF fees.
The Financial Industry Regulatory Authority’s (FINRA) Fund Analyzer, for instance, allows individuals to sort through and compare more than 30,000 products available to investors today and calculates how a fund’s fees, expenses and discounts impact the value of a fund over time.
Final Thoughts
Similar to the fees you pay for Postmates, UberEats or any other online delivery service, ETF fees are deducted from your overall investment.
So, if you buy one share of an ETF, the fees will be reflected in that final share price.
Even though there are many other factors to consider before investing in an ETF (such as benchmarks, fund liquidity and bid-ask spread – just to name few), you should prioritize fee analysis when crafting your investment plan.
Consider an investor who deposits small amounts of capital into their ETF on a regular basis (dollar-cost averaging). Due to more frequent transactions, this investor could subject their investment to more fees than someone who invests a lump-sum amount. They will want to factor those fees into the amount of capital they deposit.
As always, do your research and consider all factors to make the most informed investment decisions.
As informed investors, you are more likely to build long-term, diligent wealth.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers before engaging in any transaction.