Exchange traded funds offer investors a number of ways to capture a market at a lost cost. However, not all ETFs are created equal, so investors should still compare offerings to find the best fit.
When it comes down to calculating costs, ETF investors should consider the expense ratio, commission fees, bid/ask spread of trading and tracking errors, writes Corey Hoffstein for Forbes.
For starters, the explicit cost is easy to understand as each ETF comes with a stated expense ratio, or fee applied over time. ETFs come with fairly cheap fees, compared to their mutual fund counterparts, with an average expense ratio of 0.59% and the cheapest ETF clocking in at a 0.04% fee.
Nevertheless, there are other more implicit fees that investors should consider. For example, since ETFs trade on the stock exchange like a stock, investors can access ETFs through a brokerage platform, which comes with trading or commission fees. Nevertheless, there are a number of brokerage platforms that offer commission-free ETF trades, so investors should get better acquainted with their trading platforms. Depending on the frequency one trades, these commission fees add up, but more long-term investors may care less about one-time trades.
Additionally, since ETFs are traded throughout the trading day, traders should also watch the bid/ask spread. While two ETFs may have a bid/ask spread of one penny, ETFs trade at different prices so a low-priced ETF with a one penny spread will cost more than high-priced securities. Consequently, Hoffstein suggests investors to convert the spread into basis points since it provides a better represents of the overall percentage of an ETF’s price.
Lastly, efficiency or the ability of an ETF to closely track its index can also affect the returns. When buying or selling an ETF, an investor will be exposed to the changes in an ETF’s premium or discount to its net asset value. A wider price dispersion from the NAV could diminish returns over time. [The Various Costs of Trading ETFs]
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.