Passive index-based exchange traded funds have helped investors easily and efficiently access broad and niche areas in the marketplace. However, these index funds are not without .
Investors should keep in mind that not all index funds are low cost and tax efficient, and people should not over diversify or become too hands-on with their investments.
For starters, while many index-based funds are cheap and lauded for their low-cost advantage, some may break from the mold.
“In fact, there are a lot of high-cost index funds,” according to Morningstar analyst Mike Rawson. “Index-fund providers–fund companies that are jumping on the bandwagon, seeing all the flows to index funds–might say, ‘Well, if we put the word ‘index’ on this fund, it’s going to attract flows because people just associate indexing with maybe a fair return and low cost,’ but it’s not always the case that index funds are low cost.”
For instance, Rawson points out that there are 53 S&P 500 funds, but the cheapest charge 10-basis points or less. However, there are a number of actively managed funds or large-blend funds with an expense ratio over 1%. Consequently, the advantages of indexing may be canceled out by high fees. [The Various Costs of Trading ETFs]
“So, making the assumption that I’m automatically going to get a low-cost fund if I go with an index is something that people need to be wary of,” Rawson added.