An exchange-traded fund (ETF) deducts its expenses from the total value of the shares. These fees are typically expressed as a percentage of the fund’s average net assets and referred to as the operating expense ratio (OER). They pay the fund managers’ salaries as well as other costs, including marketing, distribution and administration. OERs vary by fund and most range from about 0.10% to as much as 0.75%. ETF expense ratio fees, while small relative to fees levied on some other investments, can significantly impact the long-term performance of an ETF investment. You can work with a financial advisor if you need help assessing the effect ETF expense ratios have on your portfolio.
ETF Expense Basics
Exchange-traded funds (ETFs) pool investors’ money to invest in portfolios of stocks, bonds and other assets. ETFs are managed by professional investment advisors. The managers may employ passive styles, similar to index funds or invest actively by buying and selling securities in pursuit of a specific objective. Unlike mutual funds, which can be bought and sold only at the end of the trading, ETFs are traded throughout the day.
ETFs charge fees for fund expenses that are expressed as a percentage of the fund’s net asset value. The fees are referred to as operating expense ratios (OERs) and typically range from 0.10% to 0.75%. The fees are used to pay the managers’ salaries, as well as other costs including expenses for marketing, accounting, legal, distribution, reporting and administration. Other costs could include interest and dividends on borrowed securities and 12b-1 fees.
ETFs do not report OERs on account statements. Instead, the costs are deducted from the net asset value of the fund and are not immediately obvious. Investors can see the actual OERs for a specific year in the fund’s audited annual report for that year. The fund prospectus will give projected estimates of what the OER will be for the current year.
How to Evaluate OERs
Expense ratios are not large in percentage terms compared to fees that may be levied on other types of investments, such as brokerage commissions. However, they can have a significant impact, especially for long-term investors. That is because, while brokerage commissions are levied only when securities are bought or sold, ETFs charge operating expense ratios every year.
Even small fund expense ratios add up over time. For example, over 30 years $10,000 invested in a fund returning 6% annually while charging a 0.75% expense ratio will underperform $10,000 invested in a fund with an identical annual return but only 0.10% expense ratio by approximately $8,000.
ETF OERs are normally somewhat lower than mutual funds. Passively managed ETFs, such as those that track indexes, normally have lower OERs than actively managed ETFs. OERs have been trending down for years. In 2021, the average OER for a fund was 0.40%, according to an annual study done by Morningstar. Some ETFs have OERS as low as 0.09% while others may be as high as 1.0%. of net asset value.
Other ETF Fees
ETF investors may also pay other fees. Brokerage trading commissions, bid-ask spreads and discounts or premiums to net asset value are other sources of ETF costs. Investors can manage some of these costs. For instance, buy-and-hold style investors will incur fewer brokerage commissions because they engage in fewer transactions than investors who buy and sell ETF shares frequently.
Investors armed with information about operating expense ratios can use it to select ETFs that will help them meet their investment objectives. All else equal, if two funds have similar portfolios and performance, the one with the lower expense ratio will produce greater gains over time.
The Bottom Line
Exchange-traded funds (ETFs) deduct costs for manager salaries and other expenses from the fund’s net asset value. These fees, called operating expense ratios (OERs), are expressed as a percentage of net assets and can be found in the prospectus and annual report. OERs typically range from about 0.10% to 0.75%. While small, OERS can have a significant impact on the performance of ETFs over long periods of time, which could end up hurting your overall portfolio performance.
Tips for Investing
- A financial advisor can help you make sense of ETF fees and manage them with a sound investment strategy. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Expense ratios aren’t the only or necessarily the most important factors to consider when selecting investments. SmartAsset’s free online Investment Return & Growth Calculator can show you how a hypothetical investment will grow over time. The calculator considers the starting amount, amount and time of additional contributions, rate of return and number of years to grow to tell how much money you’ll have at the end of the specified time.
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