by Jeff Reeves | July 16, 2013 7:00 am
When it comes to investing, exchange-traded funds — or ETFs — are a powerful tool for investors. These funds offer diversification as well as targeted bets on specific sectors or countries, giving you the strategic edge of active management without worrying about picking individual stocks or trading foreign securities on far-flung markets like Indonesia.
Unfortunately, many investors simply look at what the fund owns, but not what it costs them. This often translates into paying big-time fees to the company that operates the ETF, which eats into your returns.
One of the best ways to supercharge your profits over the long-term is to focus on low-cost ETFs. This means you keep a higher share of the profits in your own pocket instead of enriching some high-priced manager somewhere. After all, every 1% you pay in expenses shaves 1% off your profits — and over the years, that can add up in a hurry.
So if you’re a frugal consumer who clips coupons or shops around for a deal, you should take the same approach to your investment account and shop around for the cheapest ETFs. Often you can find funds that are remarkably similar to ETFs you like — but at a fraction of the cost.
Here are some examples of cheap funds to consider:
Vanguard has made a name for itself by offering low-cost, index-based ETFs. Rather than pay for pricey active managers, these funds are simply pegged to a benchmark index and reflect its returns faithfully — and cheaply — with no strings attached.
So unsurprisingly, one of the most popular ETFs out there is the Vanguard S&P 500 ETF (VOO), which gives investors a foothold in the iconic index of 500 large-cap stocks from the S&P 500. The names there are the ones you know and love — Apple (AAPL), Exxon Mobil (XOM) and Johnson & Johnson (JNJ), just to name a few of the biggies.
Why this Vanguard ETF when the SPDR S&P 500 ETF (SPY) is older and has more assets under management? Well, because the SPY charges a net expense ratio of just over 0.09% while the VOO charges just 0.05%. Both of these funds are very cheap since that works out to $9 annually on each $10,000 invested or $5 on each $10,000, respectively. But why pay more than you have to?
And remember, just because a fund is passively managed and relies on a benchmark doesn’t mean it will always be this cheap. Take the iShares NYSE Composite ETF (NYC), which is tied to a static benchmark but charges 0.25% or $25 per $10,000 invested each year. That’s five times the VOO with a remarkably similar lineup of stocks.
State Street’s (STT) Global Advisors division wins the ETF war on the small-cap front, with its brand-new SPDR Russell 2000 ETF (TWOK) charging 0.12% in expenses, or $12 annually on every $10,000 invested. The fund focuses on the iconic Russell 2000 index and constituent stocks including up-and-comers like Buffalo Wild Wings (BWLD) as well as smaller but mature companies like The New York Times Co. (NYT).
Vanguard is close behind with the Vanguard Russell 2000 ETF (VTWO) benchmarked to the iconic index of small to mid-sized companies. It charges 0.21% in expenses, or $21 annually on each $10,000 invested.
Blackrock’s (BLK) iShares also is in the running, with its iShares Russell 2000 ETF (IWM) at just 0.24% in expenses — still affordable, but not as cheap as the others.
It’s a great big world, and there’s no easy way to slice and dice the players. But the cheapest funds with the biggest footprint tend to be developed-market ETFs that focus on large-cap stocks in major economic regions. This avoids challenging frontier markets and under-the-radar stocks that are small and very volatile, but also allows for cheaper exposure because there are not as many logistical problems to overcome when researching or buying holdings.
The winner among global large caps when it comes to cost is, once again, Vanguard. Its Vanguard FTSE All-World ex-US ETF (VEU) charges just 0.15% in expenses — cheaper than even domestic small-caps. It also has a very global flavor, excluding picks domiciled in the U.S. even though it clearly has a footprint in America with multinationals like consumer king Nestle (NSRGY) and healthcare stock Novartis (NVS).
iShares is close behind with its iShares Core MSCI Total International Stock ETF (IXUS), which also excludes the U.S. but is a tiny bit more expensive with 0.16% in expenses. It also is benchmarked to an MSCI (MSCI) index vs. an FTSE one.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at email@example.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.
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