How to Analyze Total Cost of Ownership of an ETF

Total cost of ownership includes both costs related to trading and holding the investment. For investors with long time horizons, holding costs may matter more than transaction costs. On the other hand, transaction costs may matter more to investors with short time horizons.

Transaction costs occur when investors buy or sell an ETF while holding costs occur when one owns it. Holding costs include fees and other factors that can reduce an ETF’s returns during ownership. Transaction costs can affect the price of buying or selling the ETF.

The fund’s expense ratio is typically the most important holding cost for an ETF investor. The expense ratio is an annual rate that the fund charges to pay for portfolio management, administration, and other costs. It’s important to note that this is a charge from the fund, not any intermediaries.

Trading costs are also important to consider. ETFs have different turnover ratios (the percentage of the portfolio that changes from year to year) depending on their investment strategies. ETFs with higher turnover ratios may have higher transaction costs than ETFs with lower turnover. High turnover and related transaction costs can potentially add up and chip away at returns.

The most obvious transaction cost for an ETF investor is commission. Many online trading platforms boast low fees, but it is important that investors are fully aware of the costs of buying or selling an ETF.

Generally, investors who trade more frequently will pay more in total commissions. Additionally, the percentage cost per trade may be larger for smaller trades, as it might be a flat rate for any size trade.

The next transaction cost to consider is the bid-ask spread, which is the difference between the buyer’s willingness to pay for an ETF and the price they’re willing to sell it for. A wider spread may mean greater costs for the investor. This is particularly important for investors who buy or sell ETFs frequently, as opposed to long-term investors.

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