For those involved in exchange-traded funds (ETFs), costs can significantly affect your investment. Different providers, such as Vanguard and Charles Schwab, tend to offer similar options, especially when tracking the same index like the S&P 500. Generally, many investors opt for the lowest-cost option. However, experts recommend looking beyond just expense when choosing a fund to invest in.
Dan Sotiroff, a senior analyst at Morningstar, mentions that while low fees signify competition among index trackers, other factors will also play a major role in the investment decision.
Lower fees could lead to higher returns
ETFs are becoming a popular choice over traditional mutual funds when it comes to investing. They typically offer lower costs, better tax efficiency, and the ability to trade throughout the day. According to Morningstar Direct, ETF assets have surged to about $13.2 trillion from $1 trillion at the close of 2010.
The cost of investing is known as the expense ratio, expressed as a percentage of the assets. Currently, the average expense ratio for passively managed ETFs stands at 0.14%, while actively managed ones are at 0.44%.
Investors should pay attention to these figures. High costs can nibble away at profits and hinder long-term asset growth. For instance, investing $100,000 over 20 years with a 4% growth rate and a 1% fee could yield around $180,000. In contrast, without fees, it could reach approximately $220,000, based on analysis from the Securities and Exchange Commission. This shows that a lower expense ratio equates to a lesser negative impact on investment returns.
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Choosing a single ETF provider often makes sense
Sotiroff advises that while fees hold weight, other factors need consideration, such as the influence of combining ETFs from various providers. Different companies have unique methods of defining the index. If, for instance, you own a Vanguard ETF focused on large-cap stocks and are considering adding a small-cap ETF, it may be wiser to remain with Vanguard’s offerings.
This is because the size definitions for large and small-cap stocks don’t always align across different providers, which can lead to inaccurate risk and return calculations.
Mixing ETFs from different companies can distort the valuation of stocks or sectors, potentially causing you to misjudge expected exposure, Sotiroff points out. It’s generally safer to consolidate your investments with a single provider.
Liquidity plays a vital role
Another important aspect is liquidity. An ETF with low trading volume might create challenges when trying to sell swiftly, leading to a wider gap between buying and selling prices. Kyle Playford, a certified financial planner, stresses the need to assess the bid-ask spread and average trading volume.
He suggests looking for tight spreads, ideally only a few cents apart. If spreads are wider, it indicates a drop in liquidity.
In general, ETFs are more liquid, and higher trading volumes correlate with better liquidity.
However, it’s also worth noting that some ETFs can outperform lower-cost options. An actively managed ETF might deliver better returns that justify its higher fees, particularly if the difference isn’t too large, according to Playford.
There are avenues in equity and emerging market ETFs where active management has shown promise compared to passive options, especially during volatile market periods. For instance, the Avantis Emerging Markets Equity ETF, which is actively managed, holds an expense ratio of 0.33% and gained over 33% last year. This contrasts with Vanguard’s passively managed emerging market equity ETF, with a 0.07% expense ratio and a one-year return of under 25%.
