Are ETFs worth the fees?
ETFs are popular with investors for a number of reasons, but investors often find the lower operating expenses most appealing. Most ETFs have low expenses compared to actively managed mutual funds. ETF expenses are usually stated in terms of a fund's OER.
Factoring in 0.5% to 0.75% for actively managed fees is considered to be around the average. Another type of fee that investors may encounter when buying or selling ETF shares is trading commissions. These fees are charged by brokers and can vary depending on the specific broker and ETF.
The downsides of U.S. ETFs include the commissions associated with trading them. Also, given their lower fees, ETFs may not have access to certain investments available to an active manager.
For most individual investors, ETFs represent an ideal type of asset with which to build a diversified portfolio. In addition, ETFs tend to have much lower expense ratios compared to actively managed funds, can be more tax-efficient, and offer the option to immediately reinvest dividends.
Should you invest in ETFs? Since ETFs offer built-in diversification and don't require large amounts of capital in order to invest in a range of stocks, they are a good way to get started. You can trade them like stocks while also enjoying a diversified portfolio.
An ETF's annual fee is the most obvious holding cost for an ETF investor. It's taken as a percentage of an investor's stake in an ETF. An investor with a $10,000 stake in an ETF charging 1% would pay $100 in fees paid per year.
Compare the market price to the NAV to determine if the ETF is trading at a premium or discount to its NAV. If the market price is higher than the NAV, the ETF is trading at a premium. If the NAV is lower than the price, the ETF is trading at a discount.
Interest rate changes are the primary culprit when bond exchange-traded funds (ETFs) lose value. As interest rates rise, the prices of existing bonds fall, which impacts the value of the ETFs holding these assets.
| Fund (ticker) | YTD performance | Expense ratio |
|---|---|---|
| Vanguard S&P 500 ETF (VOO) | 21.5 percent | 0.03 percent |
| SPDR S&P 500 ETF Trust (SPY) | 21.4 percent | 0.095 percent |
| iShares Core S&P 500 ETF (IVV) | 21.4 percent | 0.03 percent |
| Invesco QQQ Trust (QQQ) | 19.4 percent | 0.20 percent |
Exchange-traded funds (ETFs) are ideal for beginning investors due to their many benefits, which include low expense ratios, instant diversification, and a multitude of investment choices. Unlike some mutual funds, they also tend to have low investing thresholds, so you don't have to be ultra-rich to get started.
Is it better to invest in stock or ETFs?
Though ETFs can lose money, they are still considered less risky than stocks. That's because instead of holding a few individual stocks, an ETF can hold hundreds or even thousands. The diversification across so many securities lowers the impact of losses generated by any single stock, or even a small group of stocks.
For most standard, unleveraged ETFs that track an index, the maximum you can theoretically lose is the amount you invested, driving your investment value to zero. However, it's rare for broad-market ETFs to go to zero unless the entire market or sector it tracks collapses entirely.
ETF owners benefit from liquidity as well as broad diversity in their mutual fund portfolio. There is no lock-in since they are open-ended funds providing you with the option of withdrawing your assets as needed.
You expose your portfolio to much higher risk with sector ETFs, so you should use them sparingly, but investing 5% to 10% of your total portfolio assets may be appropriate. If you want to be highly conservative, don't use these at all.
Bid-Ask Spreads
This can be one of the significant disadvantages of ETFs because it effectively increases the cost of buying and selling them. In cases where the spread is wide, it can impact the overall profitability of investing in such ETFs, particularly for those who trade frequently or require immediate liquidity.
Holding an ETF for longer than a year may get you a more favorable capital gains tax rate when you sell your investment.
The overall set of fees for an ETF is known as the expense ratio or the ETF expense ratio. ETFs typically have an expense ratio of 0.05%.
Holding too many ETFs in your portfolio introduces inefficiencies that in the long term will have a detrimental impact on the risk/reward profile of your portfolio. For most personal investors, an optimal number of ETFs to hold would be 5 to 10 across asset classes, geographies, and other characteristics.
However, like fees on mutual fund, those paid on ETFs are indirectly tax deductible because they reduce the net income flowed through to ETF investors to report on their tax returns. Other non-deductible expenses include: Interest on money borrowed to invest in investments that can only earn capital gains.
Broken ETF risk
Most of the time, ETFs work just like they're supposed to: happily tracking their indexes and trading close to net asset value. But sometimes, something in the ETF breaks, and prices can get way out of whack, especially in international markets.
Do ETFs lose value over time?
"Leveraged and inverse funds generally aren't meant to be held for longer than a day, and some types of leveraged and inverse ETFs tend to lose the majority of their value over time," Doak explained.
Free commission offer applies to online purchases of Fidelity ETFs in a Fidelity brokerage account with a minimum opening balance of $2,500. The sale of ETFs is subject to an activity assessment fee (of between $0.01 to $0.03 per $1000 of principal).
- Some ETFs may experience lower liquidity, making them harder to sell
- ETFs can close, forcing you to sell an investment earlier than expected
- Some ETFs have tracking error: Share prices may diverge excessively from the prices of underlying assets or indexes
Indexed ETFs, tracking specific indexes like the S&P 500, are generally safe and tend to gain value over time. Leveraged ETFs can be used to amplify returns, but they can be riskier due to increased volatility.
VTI and VOO are both good picks for the long-term investor in need of a core U.S. equity fund. The main difference between the two is VTI's small and mid-cap holdings. If that exposure is appealing, VTI is your choice. Otherwise, go with VOO.
