Instead of watching costs eat away at a portfolio’s overall returns, fund investors can cut down their fees and taxes through cheap and efficient exchange traded funds.
Index-based ETFs passively track an underlying benchmark, and since there are no managers actively monitoring stock trades, these passive ETFs come with low fees, with some of the cheapest costing investors only 0.04% per year. Additionally, ETFs have low turnovers – the frequency at which stocks are bought or sold within the portfolio, which diminish the amount of potential taxable events.
Nevertheless, Nathan Sonnenberg, a Morningstar contributor reminds investors to watch for market exposure, fees and tax cost ratios. [The Total Costs of Owning, Trading ETFs]
For starters, investors should have a target goal in mind. One should decide the amount of U.S. stock, international or emerging market exposure he or she is comfortable with. Consequently, people should understand what markets, countries, regions, industries, sectors and stocks an index fund might be exposed to.
Looking at fees, every fund offering comes with some sort of management fee. However, index-based ETFs typically have lower fees than active mutual funds due to ETFs’ passive nature. There are 1,641 U.S.-listed ETFs on the market with an average 0.60% expense ratio.
Moreover, since ETFs trade like stocks, investors will have to watch an ETF’s bid-ask spread or risk incurring a larger than anticipated indirect cost to trading.