Expense Ratios Don’t Matter In ETFs

March 28, 2014

 

This article was originally published on ETF.com

The first statistic investors look at when evaluating ETFs is the expense ratio. It’s also sometimes the least important. ETFs are famous for being low cost, and there’s been a spectacular race to the bottom on fees in ETFs. The game seems to be, How low can you go? The answer is very, very low.

You can now buy complete U.S. equity exposure for just a 0.04 percent annual expense ratio, with the Schwab U.S. Broad Market ETF (SCHB | A-100). You can buy emerging market exposure for a shocking 0.14 percent, with the Schwab Emerging Markets Equity ETF (SCHE | C-88).

Vanguard, iShares and others have amazingly low sticker prices too, driving the game every lower. I wrote about this recently in my blog, the Cheapest ETF Portfolio Just Got Cheaper.

But here’s the thing: None of this actually matters.

Or at least, it doesn’t matter as much as people think. That’s because, with ETFs, as with everything else, what matters most is not what you pay but what you get. And those two things can be very different.

Here’s what I mean. Consider two emerging markets ETFs: the aforementioned SCHE and the iShares Core MSCI Emerging Markets ETF (IEMG | B-98). On a headline basis, the two charge similar fees, with SCHE looking slightly cheaper:

  • SCHE: 0.14 percent expense ratio
  • IEMG: 0.18 percent expense ratio

If you were a naive investor, you might expect at the end of the year for each fund to trail its index by its expense ratio.

We monitor these funds (and all ETFs) closely at ETF.com, and one of the primary things we look at is how well these funds track their indexes. Specifically, we look at how far off its index each of these funds is over any given one-year period.

If you look at two years of data (or 252 one-year periods), the median result is as follows:

  • SCHE: -0.44 percent behind its index
  • IEMG: +0.07 percent ahead of its index

Excuse me?

 

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