Tim Huver, ETF Product Manager, Vanguard, highlights what you should be thinking about when it comes to ETF costs.
Exchange Traded Funds are ultimately just another way to access the returns of a given market index. They’re just accessed differently and have a different cost and charging structure than traditional index funds.
To advise your clients on ETF costs, you’ll need to think about a few key things. The ongoing charges, upfront costs, the holding period, and the transaction size. Compared to traditional index funds, the ongoing charges for ETFs, by which I mean the annual management charge, and any other annual cost can often be less expensive. That’s because the cost of administering an ETF is generally lower than that of a traditional fund. This can make index ETFs very attractive as an investment, as long as you fully consider the different costs involved to make sure your client gets the best deal.
For example, trading ETFs involve some upfront charges you’ll need to think about. First, you’ll have to pay stockbroker commission, or a platform charge, to access an ETF. You may also need to pay this when you trade out of an ETF.
ETFs also trade with a spread, like Unit Trusts, or currency at the bank. This is just the difference between the asking price and the selling price, and can vary a bit between different kinds of ETFs. Together these two things add to the total cost of ownership of an ETF.
The good news, is that over longer periods, the less expensive annual cost of an ETF can overcome these trading costs. While the speed and liquidity of ETFs can make them useful tools for a variety of purposes, their cost structure can make ETFs a logical choice for a long term, buy-and-hold strategy. The point in time when the lower annual costs overcome the higher upfront costs, compared to a traditional index fund, is called the breakeven point. So how long your clients needs to invest matters. But how much and how often they want to invest also affects the decision.
Whether your broker or platform charge is a flat fee or a percentage, these can add up if you trade an ETF often, say for regular investors who put a little away each month. Likewise, if they only want to invest a little at a time, upfront costs can make up too large a percentage to make ETFs economical. At the end of the day, ETFs are attractive because of their low annual charges. This can make them a useful choice for building long-term, diversified core portfolios for your clients.