When calculating the costs of owning an exchange traded funds, investors have to figure in other factors other than the explicit annual expense ratio.
Ron DeLegge for Minyanville points out that there are three inputs investors should use to estimate an ETF’s costs.
Expense Ratios
For starters, investors should look at the operating expense ratio. The expense ratio is reported in percentage terms and represents the ongoing fee that an ETF charges for managing the day-to-day operating costs. Investors should be aware that new ETFs will come with a temporary fee waiver, which help lower the expense ratio for a limited period to help attract investor money. [Why a Cheap ETF Isn’t Always Better]
According to XTF data, the average expense ratio of U.S.-listed ETFs is 0.61%, with the cheapest broad index-based ETF charging as little as 0.04%.
The Spread
ETF investors should also consider the bid/ask spread of an ETF trades. The bid/ask spread, or simply the spread, is the difference between the bidding price and asking price of a security, which is determined by basic market supply and demand. More buyers translates to more bids and more sellers translates to more asks. Typically, the asking price will be higher than the bidding prices, or the number of sellers usually exceed the number of buyers. [The Bid/Ask Spread]
Investors may incur a hidden cost as trading in funds with large spreads will eat away at potential returns since they affect the price at which an ETF purchase or sale is made.
Commissions
Lastly, investors will always notice the upfront fees for executing a trade on a brokerage account. For active day traders, commission fees can quickly add up and diminish overall returns, especially those that implement a dollar cost average in or out of a position.
Nevertheless, there are a number of online brokerages that provide commission-free trades on ETFs, including Fidelity Investments, TD Ameritrade, Charles Schwab, E*Trade, Vanguard and Merrill Lynch. [Six Popular Commission-Free ETF Trading Platforms]
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.