Cost is a major consideration when selecting from the thousands of exchange-traded funds (ETFs) with ETF expense ratios that are listed in the United States. Expensive expenses reduce portfolio returns.
Cost reduction is a key component of the investing decision-making process, and expense ratios are crucial when investors and financial advisors look for funds that are well-suited to achieve portfolio goals.
What is an ETF Expense Ratio?
Among other costs, an expense ratio shows how much a mutual fund or exchange-traded fund (ETF) spends on marketing, distribution, administration, and portfolio management. Prior to being distributed to investors, the expense is deducted from the fund’s returns.
How do Ratios of Expenses Operate?
The expenditure ratio, which can comprise different operating costs and yearly fees, is commonly represented as a percentage of a fund’s average net assets. For instance, you will pay the fund manager $4 this year if you put $10,000 in an ETF with an expense ratio of 0.04%.
The cost ratio of a fund can have a big influence on your returns over time because the amount you spend will increase along with the value of your investment.
An ETF’s fees include costs like:
- Fees for administration
- Fees for compliance
- Fees for management
- Fees for marketing
- Fees for maintaining records
- Fees for auditing
- Legal charges
- Service fees for shareholders
The net asset value (NAV) of the fund is impacted by these operating costs. An ETF’s net asset value (NAV) is the asset value per share less any liabilities, like operational costs.
Brokerage commissions, transaction fees, and other costs to financial intermediaries that you might pay for buying and selling ETF shares on secondary markets are not included in the expense ratio.
The fund’s overall yearly operational expense ratio, net of any fee waivers or reimbursements for expenses, is known as the gross expense ratio. The net ongoing charges show the ETF’s costs after the fund manager has waived or partially covered any costs.
Can various ETF kinds have varying expense ratios?
Expense ratios, which are impacted by many factors, including fund objectives and total assets, vary across the array of available ETFs:
- ETFs that invest in foreign securities generally cost more to manage than funds that invest in US Treasury bonds.
- An ETF’s expenditure ratio frequently falls as its assets rise since its fixed costs probably make up a lower portion of its net assets.
- The expense ratios of actively managed ETFs are often higher than those of passive, index-tracking funds.
ETF Expense Ratios are Usually Lower than Mutual Funds
Historically, the median expense ratio for index mutual funds is 0.90%, while the median expense ratio for index exchange-traded funds (ETFs) is 0.56%. One crucially, over time, the greater expenses of mutual funds may accumulate and affect portfolio performance.
The average ETF investment cost has been declining for several years, which is good news for investors. The average index bond ETF cost ratio decreased by 25% and the average index equity ETF ongoing charges decreased by 30% between 2008 and 2024. The average expense ratio for index equities exchange-traded funds (ETFs) decreased by one basis point to 0.40% in 2024. In 2024, the cost of index bond ETF investments decreased by one basis point to 0.20%. 2.
Where Can You Get the Expense Ratio for an ETF?
ETF screener tools are available on many fund company websites and online brokerage platforms to assist you in sorting or filtering based on cost ratio. The expense ratio is available in the prospectus or fact sheet of a fund if you are looking into a particular ETF.
Keep in Mind the Entire Cost of Ownership
Expense ratio analysis plays a significant role in determining an ETF’s cost, but it’s also critical to assess the ETF’s total cost of ownership (TCO), which accounts for holding and trading expenses. Trading expenses can mount up and affect TCO more than any difference in the expense ratios of two ETFs, depending on the size and frequency of your rebalance.
Conclusion
Perhaps the most crucial statistic for any investor to comprehend is the ETF expense ratio. Even though it might only seem like a tiny percentage, its potency comes from its capacity to compound over decades, subtly reducing a sizable amount of your long-term gains. Over the course of your investment career, a seemingly insignificant difference of merely 0.50% might result in thousands, if not hundreds of thousands, of dollars in lost gains.
In the end, one of the few aspects of the market that you have complete influence over is the ETF cost ratio you select. Your money has a better chance of growing and compounding if you continually prioritize low-cost accounts. It’s a straightforward yet effective tactic that has a significant impact on accumulating long-term wealth.
FAQ
What is a good ETF expense ratio?
A good rule of thumb is to not invest in any fund with an ETF cost ratio higher than 1% since many ETFs have expense ratios that are much lower.
Is a .35 expense ratio high?
A good expense ratio, from an investor’s viewpoint, is around 0.5% to 0.75% for an actively managed portfolio. An expense ratio greater than 1.5% is considered high.
Is 0.4 expense ratio high?
Generally, low-cost equity ETFs will have a net expense ratio of no more than 0.25%. Low-cost equity mutual funds will have expense ratios of 0.5% or lower. Low-cost bond ETFs often have expense ratios under 0.2%, while low-cost bond mutual funds typically have an expense ratio of 0.4% or lower.
What is a bad expense ratio?
A bad expense ratio could be any percentage over 1%, according to conventional wisdom.
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