Most exchange traded fund investors look at the expense ratio to gauge the cost of trading an ETF. However, there are a number of additional components that can affect one’s overall costs.
“When looking at how the industry classifies and calculates total expenses associated with buying and selling ETFs, it’s critical to break down those expenses into two categories: negotiable and non-negotiable” writes Noah Hamman, CEO of AdvisorShares, for ThinkAdvisor.
For example, when calculating the total expense for owning an ETF, investors will have to consider non-negotiable management fees, operating expenses and 12b-1 fees, if an ETF issues one.
Management fees and operational expenses can change as an ETF acquires more assets under management. Over the past few years, a number of ETF providers, such as Vanguard and BlackRock, have cut their fees due to improved economies of scale and increased assets under management. [Vanguard Cuts Fees on 22 ETFs]
Moreover, a number of fund-of-funds, or ETFs with other ETFs as an underlying holding, will incur additionally fees as so-called underlying fund fees. For instance, if an ETF includes the SPDR S&P 500 ETF (NYSEArca: SPY) as an underlying holding, the ETF will have to include the underlying fund fees of SPY. In contrast, an ETF that buys all individual 500 securities of the S&P 500 would not disclose the costs of acquiring the stocks on its expense table, although the fees will still affect the performance of the fund.
Investors also have the opportunity to diminish overall costs through negotiable fees, which include commissions and an ETF’s bid-ask spread.
For starters, traders have access to a number of brokerage options that charge varying rates. Many brokerage firms provide free trading promotions for new accounts, and depending on the size and frequency of trades, advisors can negotiate rates or ask for period rebates. Some brokerage firms also provide commission-free trades on select ETFs. [Six Popular Commission-Free ETF Trading Platforms]
Furthermore, the bid-ask spread also provides investors an opportunity to negotiate better trades. While ETFs with tight spreads don’t offer much to negotiate over, some ETFs that don’t trade as often can allow investors the opportunity to execute more efficient trades through limit orders. [The Total Costs of Owning, Trading ETFs]
“For an advisor, it’s important to recognize that ETF analytics or grading services that use posted spreads do not fully realize that the actual cost of the transaction can be—and often is—significantly better,” Hamman added. “This is the value add that advisors bring as actual practitioners of ETF trading and execution.”
For more information on ETFs, visit our 101 category.
Max Chen contributed to this article.
Full disclosure: Tom Lydon’s clients own shares of SPY.