ETF fees might seem small, but they can significantly impact your long-term returns. Understanding expense ratios and other costs is essential for making smart investment decisions. In this guide, we will explain everything you need to know about ETF fees and how to minimize them.
What is an Expense Ratio?
An expense ratio is the annual fee an ETF charges to cover operating costs. It is expressed as a percentage of your investment and is deducted automatically from the fund's returns.
Simple example: If you invest $10,000 in an ETF with a 0.10% expense ratio, you pay approximately $10 per year in fees. The fee is not billed to you directly. Instead, it is deducted from the fund's performance daily.
What Does the Expense Ratio Cover?
The expense ratio pays for:
- Management fees: Compensation for portfolio managers and research
- Administrative costs: Accounting, legal, and regulatory compliance
- Marketing and distribution: Costs of attracting and serving investors
- Custodial services: Safekeeping of the fund's assets
- Index licensing: Fees paid to index providers (like S&P or MSCI)
Typical Expense Ratios by ETF Type
Expense ratios vary widely depending on the type of ETF:
Expense Ratio Ranges
- Broad US index ETFs: 0.03% - 0.10%
- International developed ETFs: 0.04% - 0.20%
- Emerging markets ETFs: 0.10% - 0.25%
- Bond ETFs: 0.03% - 0.15%
- Sector ETFs: 0.08% - 0.40%
- Commodity ETFs: 0.25% - 0.75%
- Leveraged/Inverse ETFs: 0.75% - 1.00%
- Actively managed ETFs: 0.50% - 1.00%
Ultra-Low-Cost ETFs
Competition has driven some expense ratios to near zero:
- VTI (Vanguard Total Market): 0.03%
- VOO (Vanguard S&P 500): 0.03%
- ITOT (iShares Core Total Market): 0.03%
- BND (Vanguard Total Bond): 0.03%
- SPTM (SPDR Portfolio Total Market): 0.03%
The Real Impact of Fees Over Time
Small differences in expense ratios compound into significant amounts over long periods.
20-Year Fee Impact Comparison
$50,000 invested with 7% annual returns:
- 0.03% expense ratio: Final value = $191,584 (fees paid: $1,859)
- 0.20% expense ratio: Final value = $184,812 (fees paid: $8,631)
- 0.50% expense ratio: Final value = $174,246 (fees paid: $19,197)
- 1.00% expense ratio: Final value = $158,289 (fees paid: $35,154)
The difference between 0.03% and 1.00% is over $33,000 in lost returns!
Beyond the Expense Ratio: Other ETF Costs
1. Bid-Ask Spread
The bid-ask spread is the difference between the price buyers are willing to pay (bid) and the price sellers are asking (ask). You pay this cost every time you trade.
- Highly liquid ETFs (SPY, QQQ): 0.01% or less
- Average ETFs: 0.03% - 0.10%
- Low-volume ETFs: 0.20% or more
Tip: For long-term investors, the expense ratio matters most. For frequent traders, bid-ask spreads can add up quickly. Always use limit orders to control your entry price.
2. Premium/Discount to NAV
Sometimes an ETF trades at a price different from its net asset value (NAV):
- Premium: ETF price higher than NAV (you pay more than the assets are worth)
- Discount: ETF price lower than NAV (you get a bargain)
Well-managed, liquid ETFs rarely have significant premiums or discounts, but it can happen with international or less liquid ETFs.
3. Trading Commissions
Most major brokers now offer commission-free ETF trading. However, some specialized ETFs or brokers may still charge commissions of $0 to $10 per trade.
4. Tax Costs
While not directly a fee, taxes can be a significant cost. ETFs are generally tax-efficient, but:
- Capital gains distributions trigger taxes
- Selling for a profit creates taxable events
- Bond ETFs generate taxable interest income
Total Cost of Ownership
To truly compare ETF costs, consider the total cost of ownership:
- Expense ratio (annual ongoing cost)
- Bid-ask spread (cost when buying/selling)
- Premium/discount (price versus actual value)
- Trading commissions (if any)
- Tax efficiency (impact on after-tax returns)
Total Cost Comparison Example
Comparing two S&P 500 ETFs for a $10,000 one-year investment:
ETF A:
- Expense ratio: 0.03%
- Bid-ask spread: 0.01%
- Total cost: $4 ($3 + $1 spread)
ETF B:
- Expense ratio: 0.09%
- Bid-ask spread: 0.05%
- Total cost: $14 ($9 + $5 spread)
ETF A costs $10 less per year even though both track the same index.
How to Find an ETF's Expense Ratio
Expense ratios are easy to find:
- ETF provider website: Fund fact sheets list all fees
- Brokerage platforms: Display expense ratio in ETF details
- Financial websites: Yahoo Finance, Morningstar, ETF.com
- Prospectus: Official document with complete fee disclosure
When Higher Fees Might Be Worth It
Sometimes paying higher expense ratios can be justified:
1. Unique Exposure
If an ETF provides access to a unique asset class or strategy that you cannot find elsewhere, a higher fee may be acceptable.
2. Active Management
Some actively managed ETFs have demonstrated consistent outperformance that justifies higher fees. However, this is rare and hard to predict.
3. Specialized Markets
Emerging markets, frontier markets, and niche sectors have higher operating costs that justify slightly higher fees.
4. Small Positions
For very small positions, the absolute dollar difference between expense ratios is negligible. A 0.03% versus 0.10% difference on $1,000 is only $0.70 per year.
Fee Reduction Strategies
- Compare similar ETFs: Multiple ETFs often track the same index at different costs
- Use commission-free options: Many brokers offer fee-free trading on specific ETFs
- Avoid frequent trading: Reduces bid-ask spread costs
- Use limit orders: Get better execution prices
- Choose liquid ETFs: Tighter spreads mean lower trading costs
- Consider tax location: Hold tax-inefficient ETFs in retirement accounts
Track Your ETF Costs
Pro Trader Dashboard helps you monitor the expense ratios across your entire portfolio. See your total fee exposure and find opportunities to reduce costs.
The Race to Zero
Competition among ETF providers has driven expense ratios to historic lows. Several firms now offer ETFs with 0.00% expense ratios (though these often have expiration dates or other conditions). This benefits investors enormously but has also led to consolidation in the industry as smaller players struggle to compete.
Summary
ETF expense ratios are one of the most important factors in long-term investment success. While the differences may seem small, they compound significantly over decades. For most investors, low-cost index ETFs with expense ratios under 0.10% should be the default choice. Only pay higher fees when there is a clear, specific benefit that justifies the cost. Remember to consider total cost of ownership, including bid-ask spreads and tax efficiency, not just the headline expense ratio.
Ready to learn more about building a cost-effective portfolio? Check out our ETF basics guide or explore ETF trading strategies for maximizing your returns.