The Total Cost of ETF Ownership

Expense ratios are just one of the many costs of ETF ownership

Ben Johnson 25 May, 2010 | 4:22PM

The low cost of exchange-traded funds relative to traditional actively managed open end funds and index trackers is perhaps their most appealing feature. When looking at the cost savings of ETFs, and comparing one fund to another, most of us just look at the total expense ratio given in prospectuses and other literature. But expense ratios reflect just one of the many costs of ETF ownership. Costs of buying, selling, and potential hidden charges or earnings all affect the ultimate returns that shareholders get from a given ETF. Here, we will piece together all of the costs involved in transacting and owning ETFs to give a holistic view of the total cost of ETF ownership.

Total Expense Ratio (TER)
The total expense ratio is the most explicit cost of ETF ownership. This ratio represents the portion of your investment that will be extracted by the fund on an annual basis for their efforts. This charge covers costs incurred by the fund which can range from trading expenses to marketing budgets and custodial fees to index licensing costs. The average expense ratio across all European ETFs is 0.38%, which compares very favourably to average expense ratios for both traditional actively managed open end funds and open end index trackers. For more on total expense ratios please see our article Low Costs are the Smartest Investment.

Trading Costs
We first discussed the costs of trading ETFs in our article Tricks of the Trade. These costs include brokerage commissions, bid-offer spreads, and market impact (a topic we will touch on in further detail in the future). Furthermore, premiums and discounts to net asset value represent another important consideration (for more on this topic see this article).

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Ben Johnson

Ben Johnson  is director of passive funds research at Morningstar.

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