Exchange traded funds continue to increase in number and popularity, growing to one of the most commonly traded securities on the stock exchange as both institutional and the average retail investor gain greater access to broad or specialized market exposure. Yet many individuals are unfamiliar with ETFs’ inner workings. In this ongoing series, we hope to address your questions and help shed light on the investment vehicle. [What is an ETF? — Part 7: Bid/Ask Spread]
Before taking on any ETF investment, it is important to consider the explicit costs incurred with trading and holding a fund.
Every ETF tries to reflect the performance of a benchmark index, minus fees. Specifically, the expense ratio.
An expense ratio is a fee every ETF investor will have to pay to compensate the investment company’s costs for operating the fund, determined through an annual calculation. The management expense ratio is calculated by dividing the fund’s operating expense by the average dollar value of assets under management.
Unlike mutual funds, ETFs have a much lower expense ratio, with an industry average at about 0.55%. Some broad-based index ETFs even come with expense ratios as low as 0.05%. ETFs come with lower fees because they do not incur the higher costs associated with operating a mutual fund, such as management fees, load fees for sale and distribution, paying a board of directors, shareholder accounting expenses and service or marketing fees.