When investing in an exchange traded fund, investors should understand the total cost of ownership, which includes costs outside the expense ratio price tag.
“The expense ratio is just one component of the total cost of ownership, which can be broken down into trading costs and holding costs,” writes Morningstar analyst Michael Rawson.
Under trading costs, investors should also keep in mind brokerage commission fees, trading bid-ask spreads and potential market impact of trades. [Assessing the Total Cost of ETF Ownership: A Real World Example]
Additionally, looking at holding costs, investors need to consider sampling errors, other trading costs, securities lending and the expense ratio.
Trading costs are typically a major consideration for more short-term traders who won’t stick to an investment long enough to see significant holding costs. Moreover, large investors who have a large impact on a fund’s average daily trading volume will also take particular note of potential trading costs as they can affect a security’s price through sheer volume.
For instance, traders want tight bid-ask spreads, or the difference between the highest price a buyer is willing to pay for the ETF’s share and the lowest price at which a seller is willing to part with the share. According to Morningstar data, ETFs with more assets have tighter bid-ask spreads, and U.S. stocks have tighter spreads than less-liquid securities like bonds or international stocks that trade in different time zones. [Dissecting The Cost of Owning an ETF]