An ETF’s bid-ask spread is important, especially over shorter holding periods. But an ETF’s expense ratio becomes more important sooner than you may think.

That’s true whether an investor owns an equity ETF or a fixed income ETF.

In the case studies that follow, we present total-cost-of-ownership calculations that include both the entry spread and the exit spread—the costs of a “round-trip trade.” That’s because investors who trade in and out of ETFs, say to “equitize cash” for discrete amounts of time, incur the cost of the spread both times. 

We also focus on relatively smaller trades that execute within the quoted spreads, rather than large ETF trades that can affect the market prices of ETFs. Moreover, we do not consider premiums and discounts², which can vary a lot depending on volatility. Both are subjects for another day.

The table below makes clear that the importance of expense ratio gets flipped completely depending on holding period.   

With all these considerations in mind, we’ll start by comparing the total costs of Vanguard S&P 500 ETF (VOO) and SPDR S&P 500 ETF (SPY), the most-traded equity ETF by volume in 2022.³ Both ETFs aim to provide exposure to the stocks listed in the S&P 500 Index and seek to track the index’s performance.

SPY’s expense ratio is 0.0945% (or 9.45 basis points or bps), or more than three times as much as VOO’s expense ratio of 0.03% (or 3 basis points). This is the cost for owning the ETF for one year.

But the average of SPY’s round-trip trading spread of 0.39 basis points is less than half VOO’s round-trip spread of 0.83.⁴ This, again, is the sum of the trading cost when the ETF is bought and when it’s sold.

At first glance, we can observe two things: There’s a real difference in cost to initiate ownership of these two ETFs, and the magnitude of difference between spread and expense ratio is substantial. That said, integrating the trading costs and the expense ratio means that the break-even calculation—when the cost advantage of VOO’s lower expense ratio starts to kick in—comes in 26 days for a round-trip trade, as the chart below shows.  

The chart also shows that VOO’s lower expense ratio shines more and more beyond the point of breaking even. That’s the meaning of the widening space between the two lines. Beyond Day 26 of holding VOO, those cost advantages build and compound over time. In other words, investors can take home increasing amounts holding VOO than they would holding SPY.  

Shifting to the realm of fixed income, let’s compare two U.S. Treasury ETFs—iShares 1-3 Year Treasury Bond ETF (SHY) and Vanguard Short-Term Treasury ETF (VGSH), which offers exposure to 1-3 year Treasury bonds. The round-trip breakeven here is 17 days. VGSH has an expense ratio of 4 bps while SHY costs 15 bps per year. The trading spread on VGSH is 1.70 bps, a bit wider than SHY’s spread of 1.21 bps.¹

But as with the previous comparison, the lower expense ratio becomes more and more decisive once break-even is reached, which is to say that the advantages of VGSH’s lower expense ratio pay off increasingly over time. And as the break-evens of each example shows, it doesn’t take longer than just several days for that expense-ratio advantage to start rewarding investors.

The widening delta of extra returns over time related to a lower expense ratio is something most investors will find extremely valuable. Investing success has a lot to do with staying the course over the long haul. Relatively small differences in expense ratio can make a big difference over time.

• On its 30th birthday, the ETF looms large (article, issued February 2023)
• Tallying the total cost of owning an ETF (article, issued December 2022)
• The case for low-cost index fund investing (research paper, issued May 2022)
• Enduring investments: A leader in active management and indexing