Four ETF Cost Factors to Weigh Beyond Expense Ratios
October 9th 2012 at 6:00am by Tom Lydon
As providers fight over the ongoing price war in the race to see who can offer the cheapest exchange traded fund product, investors are jumping at the chance to cover broad markets at next to nothing prices. Still, you should not let cheap ETF fees blind you to other cost factors.
There are other factors to consider when calculating the overall cost of trading ETFs, writes John Wasik for Reuters. For instance, investors will have to take into account the bid/ask spread, underlying holdings, tracking error and commission fees.
Since ETFs are traded like stocks, investors will also have to look at the bid/ask spread, or the difference between the highest and lowest prices for buy and sell orders. As such, the tighter the spread, the better of the investor – wide spreads translates to a higher premium paid out, which adds to transaction costs. [Bid/Ask Spread]
ETFs track a basket of securities and the ETF will typically have a better bid/ask spread if the underlying assets include large- or mega-cap stocks. With thinly traded small-caps, international stocks or other niche areas, the spreads begin to widen.
Additionally, ETFs are made to try to reflect the performance of an underlying index. If the ETF starts to veer away from the index, investors will taking an implicit cost to investing in the fund - Wasik notes that anything over 0.10 percent variation is a warning sign. [Trading Costs]
Lastly, the average retail investor will buy and sell ETFs through an exchange, which typically charges a commission fee. Needless to say, these transaction fees add up for the the active day trader, but there are some brokerages that offer commission-free trades on select ETFs.
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.