An ETF is an exchange-traded fund that is traded on the stock exchange. ETFs can hold a variety of investments like bonds, stocks, commodities, and even real estate via holding REITs (real estate investment trusts). They are similar to mutual funds in concept but work very differently. Exchange-traded funds are also an excellent choice for portfolio diversification simply because they include multiple assets in a single security.
An exchange-traded fund can hold as many as hundreds or even thousands of stocks across multiple industries, or they can specialize in one particular industry, index, or sector.
What Is an ETF Expense Ratio
An ETF’s expense ratio is the fee the ETF issuer charges investors to manage the exchange-traded fund. The fee is a percentage of the ETFs average net assets.
An ETF expense ratio includes all the operating costs and management fees for the fund. The management firm calculates the fee by dividing the exchange-traded fund’s operating expenses by the total average dollar amount for all the fund’s assets.
What Affects the ETF Expense Ratio?
Factors that affect expense ratios include the types of funds, the investment category, investment strategy, and the size of the fund.
A smaller amount of assets in a fund will generally have a higher expense ratio because funding is limited to cover costs.
Why Should I Care About ETF Expense Ratios?
It’s essential to look at what you are paying in expenses and investment fees because it can make a big difference in your profits received from your investments. It is especially true when investing for an extended period. The bigger the fee, and the longer the investment period, the higher the percentage of lost return.
For example, NerdWallet has a chart that shows how a simple 1.02% fee over 10 years will cost you about 6.4% of your portfolio, but at 40 years, it costs you 25.1%! A seemingly minor 1.02% fee, over a long enough period, can cost you over a quarter of your entire portfolio value!
Investors should always research and compare expenses in a fund prospectus, stockholder report, and through various financial websites.
Do I Have to Pay an ETF Expense Ratio Out of Pocket
ETF expense ratios are expressed as a percentage of the fund’s average net assets and deducted from the fund. As a result, investors receive their total return from the exchange-traded fund less the fees.
The fees are deducted from the ETF to cover any operating expenses and management costs. This means that you do not have to pay the fees out-of-pocket.
What is Considered a High Expense Ratio
A high expense ratio for an ETF would be 1.5% or higher. It really comes down to your comfort level. Personally, I don’t look at ETFs with fees over .75%, and honestly struggle to invest in funds with fees above .50%. Ideally, I stick with funds that have expense ratios under .25%, but I do have a relatively sizable investment in a fund with an expense ratio of .50%.
What is Considered a Low Expense Ratio
Lower expense ratios range from 0.01% to 0.75%. Funds in these fee ranges tend to be managed passively. That means they generally track an index. Fees for actively managed funds or mutual funds tend to be higher. A typical ratio for passive index funds would be approximately 0.2%, but they’ve been trending down lately. The trend down in expense ratios has much to do with the competition and demand for low fee ETFs.
How Do Expense Ratios Affect My Investment Returns
Expense ratios are calculated annually and are in your shareholder reports and the fund’s prospectus. Expense ratios reduce the fund’s returns to investors because they are deducted directly from the fund and the value of your investment. The fees are deducted from investment returns before you receive them.
This means that your returns are reduced to cover the fee. Over many years, these fees can reduce the overall value of your holdings. This is why expense ratios should be watched closely. These are very sneaky fees if you don’t know about them.
When you have a typical fee, you know about it because you usually have to pay for it directly. Many people have no clue that they are paying a fee when they buy an ETF because the reduced returns hide it. This isn’t done to be tricky. It would be impractical to send a monthly or even an annual bill to every shareholder. It makes much more sense to reduce the returns before divvying them up to each shareholder.
What Are Some Example ETFs With High Expense Ratios
There are many ETFs with high fees, so I went over to ETFdb to see what the top highest fees are as of this writing. Here are the top 3:
- BIZD (VanEck Vectors BDC Income ETF), Fee: 9.62%
- VPC (Virtus Private Credit Strategy ETF), Fee: 7.64%
- BDRY (Breakwave Dry Bulk Shipping ETF), Fee: 3.5%
Yikes! In BIZD, an investment of $10,000 would cost you $962/year! Similarly, VPC would cost you $764/year, and BDRY would cost $350/year.
What Are Some Example ETFs With Low Expense Ratios
There are plenty of inexpensive ETFs, and they’re becoming more common because there is an arms race between many ETF issuers. For example, many funds managed by Vanguard, Schwab, iShares, and Invesco have almost non-existent fees!
Here are just a few examples:
- VTI (Vanguard Total Stock Market ETF), Fee: 0.03%
- SCHB (Schwab U.S. Broad Market ETF), Fee: 0.03%
- VOO (Vanguard S&P 500 ETF), Fee: 0.03%
With each of these enormously popular ETFs, a $10,000 investment will only cost you $3/year in fees! That can save you an extraordinary amount of money over a 40-year investment period. This is exactly why the robo-advisor I use, Betterment, uses mostly Vanguard and Schwab ETFs in their investment platform. To learn more about how Betterment works, read my Betterment review, and my article that examines Betterment’s pricing.
ETF Expense Ratio Wrap-up
While ETFs are usually passively managed funds with lower expense ratios, investors should always pay attention to the fees involved in their investments. You will find this information on financial websites, your brokerage research tools, the fund prospectus, and in your shareholder reports.
ETF expense ratios cover management fees and operating costs for the investment firm. The rates vary depending on the type of ETF you are investing in and how actively managed your investments are. The fees you’re paying can make the difference between whether you’re driving a Porsche in retirement, or the manager of your ETF is the one driving a Porsche.
