Exchange traded fund investors have a plethora of options and strategies to gain exposure to the various markets. Nevertheless, people should take the time to consider the associated fees that come with their investments as the costs do add up over time.
Aside from the upfront cost or commission for buying a fund, investors may largely ignore fees altogether, writes Morgan Housel for the Wall Street Journal.
For instance, in a 2013 Limra poll of 741 investors with 401(k)s and other defined-contribution plans, about half replied that they didn’t they were forking over in fees and almost a quarter thought they weren’t paying anything at all.
Investors “have no idea what they’re paying,” Christine Benz, director of personal finance at Chicago-based Morningstar, said in the article.
Moreover, even if an investor knows a fund’s costs in percentage terms, a person rarely pays attention to the actual dollar amount.
“Most investors spend about five minutes with their account statements,” Alison Salka, director of research at Limra, said in the article. “They’re mostly just checking their balance, not going through the details.”
For starters, investors can easily look up their fund investment’s fees through the provider sites or on a prospectus sheet. If an investor held $100,000 in a fund that comes with a 1% annual expense ratio, he or she is paying $1,000 per year for utilizing the fund. However, the fees are typically deducted from the investment’s overall performance, so investors rarely perceive the cost in a dollar figure.
“People would be much more sensitive to costs if they received an actual bill,” Benz added. “They look at these little innocuous-looking percentage ratios, and it doesn’t look like a big deal. They see half a percentage point versus one percentage point, and it doesn’t look like a big difference.”
However, over a long time frame, the higher fees add up to real dollar costs. For instance, Housel points out that someone who pays an industry-average of 0.74% for a stock mutual fund and invests $500 per month for 30 years will pay $33,615 more than an investor who utilizes a low-cost stock index fund that charges 0.05%, assuming both funds realize an average 6% annualized return before fees. [How Cheap Are ETFs?]
More investors are beginning to realize that the higher fees associated with active mutual funds are weighing on overall returns. For example, U.S.-equity ETFs have an average 0.53% expense ratio, and some of the cheapest index-based ETFs come with a 0.04% expense ratio, according to XTF data. [What an All-ETF Portfolio Does for You]
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.