Asset classes
The five factors that make up total ETF costs
March 07, 2024
Two decades ago, expense ratios among ETFs in a given category frequently differed by 10 to 20 basis points (bps).1 Today, the differences are often as little as 1 to 2 bps. As the range of expense ratios has narrowed, other cost-related factors have become increasingly important.
In Understanding the Total Cost of ETF Ownership, we explore each of these costs and assess their relative importance depending on an investor’s time frame, portfolio construction goals, trade size, and other factors.
The drivers of an ETF’s total cost
Many investors are familiar with the two factors that make up the bulk of an ETF’s total cost—the expense ratio and bid/ask spread.
The expense ratio is an explicit, ongoing cost that reflects an ETF’s annualized operating expenses and is factored into its net asset value (NAV). The bid/ask spread—the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept—is another explicit cost that’s realized when buying or selling an ETF.
What ETF investors don’t always consider are the implicit costs they may incur. These are the costs associated with premium/discount volatility, tracking error, and market impact costs.
Sources: Vanguard, based on data from Bloomberg.
Weighing ETF cost factors
Which ETF cost factor matters more often depends on the answers to two questions: “What’s my holding period?” and “How large is my trade?”
Low expense ratios are a proven driver of long-term performance, and they become more important as the ETF holding period lengthens. Conversely, bid/ask spreads and premium/discount volatility are generally more important for shorter holding periods. Tracking error tends to be equally important across all time horizons and trade sizes, while market impact costs typically come into play only for larger trades.
It’s unlikely that any one ETF will be the lowest-cost across all five cost factors when compared with similar products. Ultimately, the relative importance of each cost factor depends on the investor’s goals and the nuances of the trade.
For help navigating these costs, download our guide, Understanding the Total Cost of ETF Ownership.
1 A basis point is one-hundredth of a percentage point.
Related links:
- Active fixed income and our ownership structure (article, issued February 2024)
- Tracking error, the often-overlooked cost (article, issued September 2023)
- ETFs premiums and discounts, explained (article, issued August 2023)
- Case studies in the cost of ETF ownership (article, issued June 2023)
Notes:
For more information about Vanguard funds and ETFs, visit vanguard.com to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.
Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.
All investing is subject to risk, which may result in loss of principal. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.
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