Investment management fees for exchange-traded funds (ETFs) and mutual funds are deducted by the ETF or fund company and adjustments are made to the net asset value (NAV) of the fund daily. Investors don't see these fees on their statements because the fund company handles them in-house.
Management fees are just a component of the total management expense ratio (MER), which is what should concern investors.
Key Takeaways
- Management fees include expenses ranging from manager salaries to custodial services and marketing costs.
- These fees reduce the value of an ETF investment.
- They're a subset of the total management expense ratio (MER).
- MERs are generally lower for passive funds than for active ones.
- Higher fees can have a large impact on overall investment returns because fees compound over time.
ETF Fees
An ETF company incurs expenses ranging from manager salaries to custodial services and marketing costs as part of its normal operations. They're subtracted from the NAV.
Assume an ETF has a stated annual expense ratio of 0.75%. The expected expense to be paid over the year is $375 on an investment of $50,000. The investor would slowly see their $50,000 move to a value of $49,625 over the year if the ETF returned precisely 0% for the year.
The net return the investor receives from the ETF is based on the total return the fund earned minus the stated expense ratio. The NAV would increase by 14.25% if the ETF returns 15%. This is the total return minus the expense ratio.
The Impact of Fund Expenses
Fees are important because they can have a huge impact on your ultimate returns. A $100 investment that grows by 7% a year would be worth $197 in 10 years without fees. Subtract a 1% annual fee and the result is $179. Fund expenses have eaten up approximately 10% of your potential portfolio. Fees compound over time just as portfolio assets do so the longer the investing period, the bigger the loss.
Ways to Minimize Expenses
Some funds are more expensive than others. A critical distinction is passive versus active management.
Passive managers simply mimic the holdings of a stock index, often the S&P 500, sometimes with minor deviations. These "index fund" or "index ETF" managers periodically rebalance fund assets to match the benchmark index. This incurs trading costs but they're usually minimal.
As the name suggests, active managers take a greater hand in choosing fund assets. This requires expensive research departments that passive funds don't have and usually a higher level of trading that elevates transaction costs. All this is reflected in the MER.
The asset-weighted average expense ratio dropped from 0.61% in 2021 to 0.59% in 2022, the last full year for which statistics are available. Expense ratios for passive funds declined from 0.13% in 2021 to 0.12% in 2022.
Studies of ETF Fees
Morningstar estimates investors saved $9.8 billion in fund expenses in 2022, the last full year for which statistics are available. Investors are benefitting from less expensive fund options as competition between fund companies increases.
Companies are moving toward fee-based compensation models and away from traditional transaction-based models, according to Morningstar. Customer rejection of costly funds is evident in net inflows and outflows. The cheapest 20% of funds saw inflows of $394 billion in 2022. The remaining 80% saw outflows of $734 billion.
The popularity of low-cost robo-advisors is another factor driving down the cost of wealth management services and putting pressure on fund companies to keep expense ratios low. Many investors are responding favorably to the rapid digitalization in investment services and the ability to build high-quality portfolios for a minimal cost using easily accessible online platforms.
The worldwide robo-advisory market is expected to be valued at $129.5 billion by 2032, growing at a compound annual growth rate (CAGR) of 32.5% between 2023 and 2032.
Which Funds Have the Lowest Fees?
Passively managed funds like index ETFs tend to have lower fees than actively managed mutual funds. Broad-based funds tend to have lower expenses than narrowly-based funds because their management costs are distributed among a larger investor base. Vanguard claimed the lowest expense ratio among all fund managers in 2022 with average asset-weighted expenses of 0.08%.
How Much Do Brokers Charge for ETFs?
Brokerage houses may charge a commission for ETF trades just as they charge for any other market-traded security. These fees are typically around $20 per trade or less but they can add up over time if the investor trades ETFs often.
What's a Good Fee for ETFs?
The average asset-weighted expense ratio for passively managed funds was around 0.37% in 2022, according to research by Morningstar. Investors should expect to pay around $3.70 for management costs for every $1,000 of investment value.
The Bottom Line
ETF fees pay for the expenses of managing an exchange-traded fund. They include custodial costs, management salaries, and the costs of buying and selling securities. These are typically lower than the expenses for actively managed funds but they can be significant if you trade often or if the fund does poorly. These costs are automatically deducted from the fund's assets and they're reported in the fund's annual statements.
