Follow-up on ETF expenses

Oct 11, 2010

Following up on the math of ETF trading/investing expenses.   This is more important in terms of trend than anything but think about this Ameritrade offer from another angle.

Some assumptions:

1) Assume you do 30 round-trip trades in a given year for 60 total trades (30 buys and 30 sells).

2) Let's say 50% are closed within 30 days and 50% are held longer than 30 days.

The overall commissions would be 15 x $19.99 = $299.85

Using a $200,000 account value, this would represent about 15 basis points in commissions (0.15%).

If we assume that the average expense ratio is 40-60bps, then the total cost is 55-75 basis points per year (0.55% to 0.75%).

Keep in mind that daily fund pricing includes the deduction of the expense ratio.  There are 252 trading days in a year and if a fund charges 30 basis points, then there is a daily deduction of 0.0012% per day taken out of the net asset value.  This is in turn reflected in the daily closing prices -- the point being that the expense ratio does not need to be deducted again when we are already using closing prices in our analysis at -- thus the costs are just the commissions, which are 15 basis points in this example. For a $500,000 account, the total annual cost of commissions is just 6 basis points 0.06%

While much time is spent discussing expense ratios and savings -- the differences between ETFs are trivial in context of markets that can move percentage points in just a few hours.

The bottom line is that ETF investing is extremely low cost.  Comparing expense ratios between ETFs at this low level is a waste of time. It just isn't important.



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Comments (2) -

Nov 06, 2010 13:58 #

what about spreads? that adds also to ETF expenses.

hugos Germany

Nov 07, 2010 06:09 #

You are correct.   However, reveiew the 2 core alternatives:

1) Commissions will be dramatically less using ETFs vs individual stocks since we can build diversified portfolios with a much smaller list of ETFs

2) Mutual funds can be bought/sold at the NAV --- but at only 1 price per day.   A bid/ask spread for a liquid ETF is often 1 cent and is available at any time during the day.   Limit orders can be used in cases of wider spreads.   Having the bid/ask spread is a very small transaction cost that by its nature opens up many more choices for entries than the mutual fund alternative.

Chris United States

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