While anyone can look up the direct costs associated with any exchange traded fund investment, such as an expense ratio or commission fee, investors should also consider the indirect costs that may not be so straight forward.
According to Morningstar’s “ETF Total Cost Analysis in Action” research note, Paul Justice, CFA, Director of ETF Research, and Michael Rawson, CFA, ETF analyst, reveal the true cost of owning an ETF. [Trading Costs]
For starters, Morningstar’s ranked 4- or 5-star ETFs have ratings that are correlated with low costs and outperformance from their respective underlying Indices. In contrast, lower-rated ETFs have higher tracking volatility – deviations that occur between the ETF’s price and its underlying net asset value – and market impact costs – the measure of an ETF’s liquidity. [True Liquidity]
The authors found that ETFs launched before 2005 tend to have lower holding costs, smaller tracking volatility and less market impact than newer products. For instance, ETFs issued since 2008 exhibited tracking volatility almost five times that of ETFs that have been around before 2005.
Additionally, ETFs with higher expense ratios, like those that track alternative investments, have higher implicit costs in both tracking volatility and market impact. ETFs in the Morningstar’s Trading-Leveraged Equity category had an average expense of 0.95%, whereas the Large Blend category had an average expense of 0.19% – the ETF industry average expense ratio is about 0.55%.
For more information on ETFs, visit our ETFs 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.