Exchange traded fund sponsors are trying to one-up their competitors as they slash fees to attract investors. While the ongoing fee war helps investors reduce the cost of investing in ETFs, people should still consider the implicit costs of moving assets into a low-fee fund.
While an expense ratio is the simplest way to measure the cost of investing in an ETF, it is not the only consideration, writes Elizabeth MacBride for CNBC. For those who are seeking to change out more costlier investment options, the new low expense ratios should also justify the total cost of shifting around assets in a portfolio. [ETFs: Tax Efficient and Cheap Investment Vehicles]
Specifically, MacBride points out that investors should consider if shifting into cheap ETFs is worth it, how the new ETF investment performs, potential commissions to execute trades and the sustainability of an ETF with a low expense ratio. [The Total Costs of Owning, Trading ETFs]
Investors should calculate the breakeven point of shifting assets over to a low-fee fund. If you plan on holding onto the investment for a long period, the compounding effect of an investment with a low fee will help investors realize greater returns.
Nevertheless, people should also keep in mind that ETFs are not all created equal and will have varying performances. Rob Nestor, head of iShares product strategy at BlackRock, points out that two index-based ETFs in the same asset class can generate diverging performances due to the make-up of their underlying benchmarks or the way the ETFs are managed. For instance, the MSCI and FTSE are split over the classification of South Korea as an emerging or developed economy.
Additionally, David Kreinces, founder and portfolio manager of ETF Portfolio Management, argues that the higher return in iShares Cohen & Steers Realty Majors (NYSEArca: ICF) more than makes up for its costlier expense ratio, compared to the cheaper Vanguard REIT ETF (NYSEArca: VNQ).
Commission fees also play a part when an investor evaluates the total cost of owning an ETF. If a portfolio is rebalanced several times a year, commission fees could add up. However, there are a number of brokerage platforms that offer commission-free trades on a number of ETFs. [Six Popular Commission-Free ETF Trading Platforms]
Lastly, investors should take a look at the ETF’s size to infer the sustainability of the investment product. As new products hit the shelves, sponsors may launch ETFs with low expense ratios to compete with existing funds that have gathered a first mover advantage. The low fees may help attract attention, but if the ETF offering falls on deaf years, the fund may be shut down. Over the past few years, ETFs that have been unable to gather enough assets have been axed. [ETF Closures: Not a Cause for Alarm]
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.