ETF Fees & Cost Efficiency
Always remember — It’s what you keep, so you must consider results after tax. At the end of the day, you don’t want to get a tax bill because a mutual fund or hedge fund deemed it had to sell part of your position. When we talk about cost efficient investing, we refer to the good things ETFs can do for you. When you’re investing autonomously, you don’t sell until YOU deem such is necessary. While an automated platform may choose to sell one of your ETFs, it is important to understand that they have the ability to swap ETFs at times among the universe of ETFs they hold. Swaps won’t generate a tax event for you. That’s part of investing cost efficiently. Taxes are a cost.
While we make the case that ETFs are generally more cost efficient and lower cost; they aren’t free. ETFs come with expense ratios covering the issuer’s costs of putting them together, re-balancing the investments when needed and for other administrative costs. Expense ratios are expressed in basis points. A 100 basis points figure is equal to 1%. Therefore if an expense ratio is 20 basis points, your fee would be 1/5 of a percent or 0.20%. The dollar amount paid is assessed as a percentage of your investment. That 0.20% expense ratio denotes that on a $10,000 investment you would be charged $20 a year to own that ETF. You’ll find that most ETF expense levels are lower when compared to similar mutual funds. Buying ETFs with lower expense ratios allows you to keep more of the ETF’s return for yourself.
There are ETFs created in spaces that are more costly to run. Bond ETFs are one example as they generally have higher ticket costs, higher Bid-Ask Spreads (“BAS”) and other transactional costs. <See more about “BAS” below.> Instruments that need to be acquired in international markets, especially emerging markets, are more costly. ETFs that have strategies requiring more frequent adjustments are also more costly due to the higher activity required. That’s why these types of ETFs naturally come at higher expense ratios. Examine whether you feel the higher expense ratio for the ETF you’re considering for your portfolio is justified compared to other ETF alternatives. Compare the returns of the higher cost ETF with lower cost ETF alternatives that could bring you to a similar place. This assumes you can construct a more cost efficient portfolio that’s close to the space you seek.
BAS. More often than not, you’ll find that the bid-ask spread for ETFs is generally wider (bigger and hence more costly) than for mutual funds and single stocks. <Search “bid-ask spreads” for more information.> Threadvest’s ETF Miner works behind the scenes for you when you prioritize that you want to see ETFs with lower spreads. In the end, we believe you’ll find that if you intend on holding the ETF for a longer period of time such as 6 months or more, you’ll find that the cost efficiencies in the ETF win out over similar mutual funds and single stock investments. Its what you keep.