It's no secret that the exchange-traded fund (ETF) space has grown at a tremendous pace in the past several years. There are currently thousands of ETFs available to investors, covering a diverse array of strategies and markets, and there are more launching all the time. Along with the growth of the ETF space (and likely also fueling it), investor fees to take part in ETFs have been diminishing over time. These fees, known as expense ratios, are one of the most enticing aspects of the ETF landscape for many investors. While some other products retain relatively sizable commissions and fees, ETFs have been getting cheaper for investors.
However, a recent report from CNBC suggests that savvy investors should look beyond the promise of a dwindling expense ratio before taking part in an ETF investment. Below, we'll explore why this is the case and discuss how fees still come into play when choosing an ETF.
A Bit of Background
ETF expense ratios have been trending downward for about 20 years, per CNBC, but most of this activity has taken place since about 2013. Index equity ETF expense ratios fell to an average of 0.21% in 2017; eight years prior to that, this level was 0.34%. Expense ratios for index bond ETFs have been on a similar trajectory, as are those for many other types of ETFs. All of this contributes to a general rule of thumb for those looking to make long-term investments in the ETF space: find the lowest expense ratios available. The thinking has traditionally been that these small instances of saving can eventually add up over the course of an investment career.
Beware of Hidden Fees
The CNBC report suggests that investors should "watch out for higher, hidden fees" in the same funds that have exceptionally low expense ratios. Investors may find themselves being lured into buying products with higher fees as time goes on or into paying more money for expert advice.
A key thing for investors to keep in mind is that fund providers are still in need of their own profits. No matter how much expense ratios diminish, providers will offer funds only if they believe them to be profitable for one reason or another. For some investors, the shift from a space in which providers market funds based on performance to one in which they try to sell funds based on their low fees is a suspect one.
Investors could be caught by surprise when a seemingly low-cost ETF ends up having a high set of back-end and advisory fees, for instance. While these fees can be difficult to assess, given the way that most ETFs are marketed, investors should do what they can to learn about other fees besides the expense ratio before investing.
What Should Investors Do?
Research firm CFRA's director of ETF Research Todd Rosenbluth suggests that investors may not always wish to seek out the lowest expense ratio. Given that the ETF landscape is highly competitive with regard to fees, it's likely that any particular ETF substrategy has multiple funds offering fees that are within a very small range. It may be worthwhile to pay 0.2% in fees for a fund that outperforms a competitor offering a fee of 0.16%, for example.
Investors tend to look to ETFs as long-term investments, and it's important to remember that some fees will accrue over the duration of the investment. Looking to a total fee calculation over a multi-year period can be a useful way to catch costs that may otherwise have been hidden.
Perhaps the most important thing for investors leary of ETF fees, though, is to remember that fees are only part of a much larger picture. An investor should always be thinking of her portfolio overall, including risk, return, fees and many other components. Don't be sold on a low-cost ETF simply because the fee is small; rather, consider it as one component of a larger portfolio, and make sure that the investment actually fits with what you need.