This article was provided courtesy of ETFtrends.com
While everyone can just sit back and enjoy the expense ratio cuts as the result of the so-called fee war, investors should still be wary of other costs to trading exchange traded funds.
Expense ratios are not the only costs associated with ETF investments. Bid-ask spreads – the price difference between the buying price and the selling price – and commission fees are just some other factors to consider.
The bid-ask spread is found by taking the bid subtracted from the ask, divided by the share price and multiplying by 100. [Read More: Bid-Ask Spread]
“The ETF expense ratio is an ongoing annual charge, whereas the bid-ask spread and commission costs are at the time of a transaction,” Joel Dickson, senior ETF strategist at Vanguard, said in a Wall Street Journal article.
Michael Iachini, managing director of ETF research for Charles Schwab Investment Advisory Inc., though, has offered a simple formula to convert expense ratios, bid-ask spreads and commission fees to a single per-year percentage expense:
- First off, the expense ratio remains as a percentage.
- The per-year, bid-ask spread percentage is calculated by dividing the current spread with the holding period. For instance, if an investor holds a fund for half a year, the spread is divided by 0.5, and if the fund is held for 2 years, divide by 2.
- Lastly, the commission is taken out whenever you buy or sell a fund, unless the brokerage offers commission free trades. The commission per-year percentage conversion is taken by multiplying the commission fee by 2, divided by the total dollar amount invested and then multiplying by 100.
- ETF investors can then add up the three numbers to calculate the total annual cost in percent terms.
Since the calculations are based on a time component, the total cost for long-term holders will inevitably be lower than for short-term traders.
Additionally, potential investors should be aware of other implicit costs, like premiums or discounts to underlying holdings, that may hurt or help performance. [Read More: Premiums and Discounts]
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