Exchange traded funds are touted as cheap and efficient investment vehicles that help investors achieve their goals. However, people should carefully consider the various factors of trading and holding an ETF lest they get blindsided by unforeseen costs.
For starters, ETF investors will most likely look to an expense ratio to get a sense of how much they will be paying for using the investment vehicle. There are currently 1,948 U.S.-listed exchange traded products, which include both ETFs and exchange traded notes, with an average expense ratio of 0.58% – for every $1,000 invested in a fund with a 0.58% expense ratio, an investor is paying $5.8 dollars in fees that are taken out of the fund’s overall performance.
Most investors have no idea what they are paying when investing, even if they are given fees in a percentage term. Investors would typically just spend a couple of minutes glancing over account statement and checking balances without diving into the details, especially since expense ratios are typically deducted from the investment’s overall performance, so investors rarely notice the cost in dollar terms.
To help lower fees, long-term investors should consider ETFs with low expense ratios. For instance, some broad stock ETF options now come with a dirt cheap 0.03% expense ratio, including the iShares Core S&P Total US Stock Market ETF (NYSEArca: ITOT), Schwab U.S. Large-Cap ETF (NYSEArca: SCHX) and Schwab U.S. Broad Market ETF (NYSEArca: SCHB).
Additionally, many do not factor in commission fees or the cost of trading ETFs on a brokerage when calculating their investment portfolio’s overall performance.
“Factoring in the impact of commissions can be particularly relevant for active investors who trade somewhat frequently – especially if you are making relatively smaller trade sizes – as well as long-term investors executing a dollar cost averaging strategy,” according to Fidelity Investments. “When it comes to the impact of commission costs, trade size matters.”
For example, assuming a $7.95 commission fee per trade on a brokerage account, executing a trade of $1,000 in funds to buy and sell an ETF would equate to $15.90 in trading fees, or committing 1.6% of the investment toward commissions.
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On the other hand, if one were to buy or sell an ETF with $30,000 in funds, the same $15.90 in commissions would make up just 0.05% of the total trade.
As a way to better manage ETF trading costs, traders should find out if their brokerage offers commission-free ETF trades. Commission free ETFs may help investors manage costs of rebalancing and rotating in and out of various ETF trades.