The Hidden Costs of an ETF

When looking at the cost of an exchange traded fund, its expense ratio can be the only factor advisors look at, InvestmentNews writes. However, the true cost goes beyond that, with many more factors for advisors to consider, according to the publication

The Expense Ratio Is Just the Tip of the Iceberg

Speaking at the Financial Planning Association's annual conference, Maggie Dorn, vice president and ETF specialist at American Century Investments, said that there were both obvious and less conspicuous costs to consider, InvestmentNews writes.

Explicitly, there is the expense ratio, which includes custody costs, management fees, and acquired fund fees and expenses, the publication writes. There is also the trading cost — the spread between the asking and bidding prices, combined with commissions, according to InvestmentNews. 

However, there is also the possible cost of capital gains tax, which, while less likely for an ETF than a mutual fund, can still be an issue, the publication writes. While ETFs often trade in kind, some transactions still have to be made in cash, InvestmentNews writes. 

Moreover, tracking error, which can happen if a funds’ holdings are illiquid, can also affect the cost, according to the publication. Additionally, Dorn noted the importance of placing limit orders rather than market orders when pricing is less certain, InvestmentNews writes.

“Market orders are what blow people up on ETF trades," she said, according to InvestmentNews. 

Advisors should also consider the opportunity costs of one ETF versus another, because even funds using the same benchmarks or Morningstar categories can be different due to turnover, spread, expense ratio, capital gains and returns, according to the publication. Furthermore, just like with mutual funds, ETFs cover all kinds of sector concentrations and exposures, InvestmentNews writes. 

Overall, however, it’s important to look at the “net-of-fees performance” rather than the fees themselves, according to Dorn, the publication writes.


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