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Uncovering ETF Fees

There’s little debate that exchange-traded funds (ETFs) have democratized investing. In addition to offering access to previously hard-to-reach parts of the market (think commodities and precious metals), ETFs have helped drive down investing costs in many areas of the market.

However, even relatively low fees and expenses can add up over time. So here are three costs to consider when investing in ETFs, and how to keep them to a minimum.
 

1. Commissions

When you buy and sell ETFs, your brokerage company may charge a trading commission, which covers the costs associated with executing and clearing a trade. Some brokerage firms offer commission-free trades on certain ETFs, while Schwab offers them on all ETFs. But if you’re paying a commission to trade ETFs, there are a few things to know:

  • The more often you trade, the more you’ll pay in total commissions.
  • Most firms charge a flat fee, so the percentage cost will be larger for smaller trades than for larger ones.
  • If you’re buying in person or over the phone, you’re likely to pay a higher commission than if you trade online.


Commissions are important for everyone to consider. But because commissions will play a more significant role in your total cost of ownership if you trade frequently or in small dollar amounts, active traders, in particular, should pay attention to the cumulative cost of commissions.
 

2. Expense ratios

The expense ratio is the annual rate a fund charges to cover its operating costs. Fund managers collect a small portion of the total annual expense from the ETF each day. As a result, the longer you invest in a fund, the higher the cumulative cost of this fee will be.

Also, be sure you understand the difference between an ETF’s net expense ratio and its gross expense ratio. The former is what shareholders pay as a result of the temporary fee waivers some ETF managers have introduced to attract new investors. The latter is what shareholders pay if and when those waivers expire. So, if you see a fee waiver in the prospectus, look for the expiration date and know that the fund could cost you more in the future.
 

3. Bid/ask spread

When you research ETFs, it’s easy to overlook the bid/ask spread, which is the difference between the market price at which a market maker is willing to buy an ETF (the bid) and the price at which the market maker is willing to sell it (the ask). It’s not a fee, per se, but rather a cost of investing.

Bid/ask spreads are often a reflection of an ETF’s liquidity. Popular, highly liquid ETFs, such as those that track the S&P 500® Index, tend to have very small bid/ask spreads. That’s because there’s enough demand for both the ETF and the underlying securities it holds that the market maker assumes little risk in facilitating transactions.

But with less-liquid ETFs—ones that access niche areas of the market, for example—market makers may have a harder time finding buyers and sellers, which increases their risk of facilitating a trade. To make up for this risk, the market maker charges you a higher ask when you buy the ETF and offers a lower bid when you’re ready to sell it, effectively eating into your potential profits. The more frequently you trade and the larger the spread on each transaction, the more relevant this cost becomes.
 

Greater transparency

Despite the fact that fund fees have plummeted over the past two decades, it still pays to do your homework. Spending a few extra minutes to evaluate the true cost of an ETF can help you make sure that headline fee you’re paying isn’t too good to be true.

What You Can Do Next

  • Read more insights about investing in ETFs.

  • Schwab clients can log in to compare ETFs by expense ratio, bid/ask spread and whether they’re trading at a discount or a premium.

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Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

The standard online $0 commission does not apply to large block transactions requiring special handling, restricted stock transactions, trades placed directly on a foreign exchange, transaction-fee mutual funds, futures, or fixed income investments. Options trades will be subject to the standard $.65 per-contract fee. Service charges apply for trades placed through a broker ($25) or by automated phone ($5). Exchange process, ADR, foreign transaction fees for trades placed on the US OTC market, and Stock Borrow fees still apply. See the Charles Schwab Pricing Guide for Individual Investors for full fee and commission schedules.

All ETFs are subject to management fees and expenses.

Investing involves risk, including loss of principal.

Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost. Shares of ETFs are not individually redeemable directly with the ETF. Shares are bought and sold at market price, which may be higher or lower than the net asset value (NAV).

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