ETFs are cheap, but not always in the way you think.
ETFs have probably done more to improve investor outcomes than any innovation in financial services since the mutual fund. A big part of that is the cost equation. The average equity ETF, for instance, has an expense ratio of just 0.45%, vs 1.37% for the average equity mutual fund.
But headlines aren’t the whole picture. How should you think about your real, total costs of ownership. Ultimately, it breaks down into four components.
1. Internal Costs
The most obvious costs are the ones written right on the label. You can go to any ETF here at ETF.com just by adding /(ticker) to the end of it. Want to see the expense ratio for the PIMCO Total Return ETF (BOND | B)? Just type “etf.com/bond” into your browser and a full description of the ETF is right there on the page.
But that number is a bit more complicated than you might think. Two costs are typically quotes for ETFs.
A “management fee” is the amount the fund issuer charges the fund for management. The “expense ratio” is all of the expenses of the fund divided by average assets. It’s further complicated by the fact that issuers will often cap the total expenses at a certain level, voluntarily covering fund expenses above a certain amount. We quote the all-in, capped cost generally.
There can also be surprises in this total expense number. If a fund has to pay dividends on short positions, or has to account for tax liabilities, you can see some surprisingly large numbers. You’ll generally see those outliers explained in the text of our reports.
Are these costs always cheaper than mutual funds? Not necessarily. ETFs can be less expensive for issuers to run—no shareholder servicing costs, no 12b-1 fees and no externalized trading expenses—but some of the cheapest mutual funds give ETFs a run for their money.
Still, in most cases, similar strategies are going to be cheaper in an ETF wrapper than in an open end mutual fund wrapper.