Exchange traded funds are touted as cheap and efficient investment vehicles that help investors achieve their goals. However, people should carefully consider the various factors of trading and holding an ETF lest they get blindsided by unforeseen costs.
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For starters, ETF investors will most likely look to an expense ratio to get a sense of how much they will be paying for using the investment vehicle. There are currently 1,948 U.S.-listed exchange traded products, which include both ETFs and exchange traded notes, with an average expense ratio of 0.58% - for every $1,000 invested in a fund with a 0.58% expense ratio, an investor is paying $5.8 dollars in fees that are taken out of the fund's overall performance.
Most investors have no idea what they are paying when investing, even if they are given fees in a percentage term. Investors would typically just spend a couple of minutes glancing over account statement and checking balances without diving into the details, especially since expense ratios are typically deducted form the investment's overall performance, so investors rarely notice the cost in dollar terms.
To help lower fees, long-term investors should consider ETFs with low expense ratios. For instance, some broad stock ETF options now come with a dirt cheap 0.03% expense ratio, including the iShares Core S&P Total US Stock Market ETF (NYSE:ITOT), Schwab U.S. Large-Cap ETF (NYSE:SCHX) and Schwab U.S. Broad Market ETF (NYSE:SCHB).
Additionally, many do not factor in commission fees or the cost of trading ETFs on a brokerage when calculating their investment portfolio's overall performance.
"Factoring in the impact of commissions can be particularly relevant for active investors who trade somewhat frequently - especially if you are making relatively smaller trade sizes - as well as long-term investors executing a dollar cost averaging strategy," according to Fidelity Investments. "When it comes to the impact of commission costs, trade size matters."
For example, assuming a $7.95 commission fee per trade on a brokerage account, executing a trade of $1,000 in funds to buy and sell an ETF would equate to $15.90 in trading fees, or committing 1.6% of the investment toward commissions.
On the other hand, if one were to buy or sell an ETF with $30,000 in funds, the same $15.90 in commissions would make up just 0.05% of the total trade.
As a way to better manage ETF trading costs, traders should find out if their brokerage offers commission-free ETF trades. Commission free ETFs may help investors manage costs of rebalancing and rotating in and out of various ETF trades.
"If you are an investor making relatively small trades, or an active investor who is frequently buying and selling ETFs, these savings can really add up," Fidelity said.
A number of trading platforms now offer a range of commission-free ETFs. For example, along with free trades on its own line of ETFs, Fidelity Investments has expanded its partnership with BlackRock (NYSE:BLK) to include free coverage of the iShares "Core" series. However, potential traders should note that if a sale is executed within 30 days of purchase, investors will incur a short-term trading transaction of the regular commission fee of $7.95.
Charles Schwab's OneSource ETF platform includes a large selection of over 200 commission-free ETFs over a range of asset categories from 16 fund sponsors, including States Street (NYSE:STT), PowerShares, Guggenheim, ETF Securities and U.S. Commodity Funds, among others. Since there are no short-term trading restrictions placed on the ETFs, active traders may find the platform appealing as a cost-free way to move in and out of broad market segments.
The TD Ameritrade (NASDAQ:AMTD) platform offers a broad 101 commission-free ETFs from eight different sponsors, including iShares, Vanguard, State Street, PowerShares, WisdomTree, Market Vectors, PIMCO and iPath exchange traded notes. However, if sales are executed within 30 days of purchase, investors will incur a short-term trading transactions of $19.99 - the regular commission on trades is $9.99.
E*Trade does not include products from the four largest ETF providers but offers commission-free trades on 117 products from WisdomTree (NASDAQ:WETF), Global X and Deutsche X-trackers. If sales are executed within 30 days of purchase, investors will incur a short-term trading transactions of $19.99 - the regular commission on trades is $9.99.
The Vanguard platform includes access to its proprietary ETFs. It only offers commission-free trades on its own ETFs. The firm also allows traders to buy and sell the same ETF 25 times over a 12-month period without restrictions. If a trader goes over its allotted quota, Vanguard will restrict trading on the ETF for 60 days. Regular commissions varies but starts at $7 on accounts with less than $500,000.
Bank of America's (NYSE:BAC) Merrill Edge self-directed investing account provides investors, whom maintain at least $25,000 in cash on the Merrill Lynch brokerage account or in a BofA account, with 30 commission-free trades per month on all available equities and ETFs.
This article was provided by our partners at etftrends.com.