ETF providers’ endless battle against each other to offer the lowest fees and total expenses no doubt benefits the “little guy.”
Over the years, there have been several rounds of “fee wars” between the likes of Vanguard, Charles Schwab (SCHW), BlackRock’s (BLK) iShares and others. Generally, this involves dropping the expense ratios on competing ETFs to rock-bottom levels to attract assets and attention to their funds.
On another front, Vanguard recently announced that it will be doing a reverse 2-for-1 split on its widely held Vanguard S&P 500 ETF (VOO). This will essentially double the price of the fund on Oct. 24 from its current level of $77 per share.
The reason cited was to lower transaction costs for those buying and selling VOO, but in reality, this will mean basically nothing to you, the retail investor. VOO already is a very heavily traded ETF with a tight bid/ask spread and economical expense ratio of just 0.05% annually, or $5 of every $10,000 invested. This change should actually benefit institutional investors, who are trading thousands of shares (and thus millions of dollars) daily. By raising the price, it will actually lower transaction costs, putting VOO more in line with its competitors, the SPDR S&P 500 ETF (SPY) and the iShares S&P 500 ETF (IVV).
For the majority of investors, these are the most important characteristics to consider when trading and investing in ETFs.
Internal ETF expenses generally range anywhere from 0.05% to over 2% annually. Recent industry data suggests that the average ETF expense ratio is 0.61% according to Morningstar. Traditionally you would pay at least twice that for an actively managed mutual fund equivalent. In addition, ETFs do not charge front- or back-loaded sales charges, 12b-1 fees or any other hidden expenses.
The one caveat is that ETF expenses can vary widely between competing providers, so often times, doing a little homework can save you a boatload of money. One example of a significant fee disparity for a comparable ETF is the iShares Dow Jones US Real Estate ETF (IYR) vs. the Vanguard REIT ETF (VNQ). While the underlying holdings are quite similar, VNQ has the advantage of a miniscule 0.1% expense ratio as compared to 0.46% for IYR. Vanguard and Charles Schwab are leading the pack with the lowest-cost ETFs in the industry.
More and more brokerage companies are offering access to commission-free ETF trades, which can be a significant advantage in your total investment expenses. This is especially true for smaller accounts, where a trading fee as low as $8 to buy or sell still can be cost-prohibitive.
Another advantage for commission-free ETFs is that you can trade as often as you like and in whatever quantity you desire. This will allow you to scale in and out of positions with multiple orders or set stop-losses and not worry about the impact of trading costs on smaller-sized holdings.
Investors with larger accounts or long-term strategies might not be as concerned about the impact of trading commissions on their ETF portfolio. However, it still should factor into the total return and cost of the positions over time.
I consider liquidity to be a “stealth cost” on an investment portfolio because it is easy to overlook. Often times, ETFs that are thinly traded or have underlying holdings with low volume are at risk for scalping your hard-earned money. This can occur when the bid/ask spread widens to abnormal levels or the market maker takes advantage of a drought in liquidity.
One way to avoid getting a bad fill on entering or exiting an ETF is to use limit orders to ensure that your trades are executed at the price you desire. That way you are not susceptible to the whims of the market and ensure your trade will be a success. If your trade is not filled at a reasonable price, then you can adjust your limit order or walk away knowing that you dodged a bullet.
David Fabian is Managing Partner and Chief Operations Officer of Fabian Capital Management. As of this writing, he was long IYR. Learn More: 3 Tenets Of Sound Risk Management