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.
FAQs
ETF fees are accrued daily, which means they are reflected in the daily price of an ETF; however, the fees are typically deducted from fund assets on a monthly basis. From the investor's perspective, ETF fees are not directly paid like a monthly bill. Instead, they are reflected in a fund's net return.
How are fees taken from an ETF? ›
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.
How often are ETF fees deducted? ›
ETF fee example
Each day, approximately 1 cent would be accrued ($4/365 days), and then deducted on a monthly basis, so after 12 months your investment would be worth around $9,996 (assuming no change in the market value of the fund holdings).
Are ETF fees tax deductible? ›
However, like fees on mutual fund, those paid on ETFs are indirectly tax deductible because they reduce the net income flowed through to ETF investors to report on their tax returns. Other non-deductible expenses include: Interest on money borrowed to invest in investments that can only earn capital gains.
What is a reasonable ETF management fee? ›
Expense ratios can range from as low as 0.03% for some passively managed ETFs to over 1% for actively managed or specialized ETFs. Factoring in 0.5% to 0.75% for actively managed fees is considered to be around the average.
How much should ETF fees be? ›
Investment fee
It's taken as a percentage of an investor's stake in an ETF. An investor with a $10,000 stake in an ETF charging 1% would pay $100 in fees paid per year. However, you won't see this charge on your brokerage account. It is automatically taken from your ETF as part of the unit price.
Does Vanguard charge fees for ETFs? ›
*Vanguard average ETF and mutual fund expense ratio: 0.08%. Industry average ETF and mutual fund expense ratio: 0.44%. All averages are asset-weighted.
Is a 1% management fee high? ›
But in general, a 1% management fee is right in line with market averages. Typical financial advisors might charge between about 0.5% on the lower end and 2% on the higher end, but 1% is not unusual.
Do you pay taxes on ETFs every year? ›
If you sell shares in most ETFs within a year, any profits are taxed as a short-term capital gain. ETFs held for longer are considered long-term gains and given a lower rate. If you sell an ETF and buy the same (or a substantially similar) ETF after less than 30 days, you may be subject to the wash sale rule.
Which ETFs have no fees? ›
Here are five no-fee ETFs to help you keep your investing costs down:
- BNY Mellon US Large Cap Core Equity ETF (ticker: BKLC)
- BNY Core Bond ETF (BKAG)
- Gabelli Love Our Planet & People ETF (LOPP)
- Gabelli Commercial Aerospace & Defense ETF (GCAD)
- Amplify Cash Flow Dividend Leaders ETF (COWS)
When management fees are part of the cost to invest they can be claimed on your tax return. Include the fees in D15 - Other deductions of the supplementary section.
How long should you hold an ETF? ›
More Long-term Capital Gains
Low turnover often means a longer holding period for each of the underlying investments. ETFs generally hold underlying securities longer than 12 months, which usually qualifies any gains that are realized for favorable long-term capital gains tax rates.
What is the deduction of ETF? ›
Long-term capital gains from gold, debt, or international ETFs are taxed at 20% with indexation benefits. Short-term capital gains are added to the investor's annual income and taxed according to the applicable income tax slab rates.
Are ETF fees automatically deducted? ›
Every investment has a cost, even if you don't realise you're paying it. When you invest in an ETF or a managed fund, fees go to fund providers. They're a set cost, as an annual percentage and deducted automatically.
How to calculate ETF fees? ›
ETFs typically have an expense ratio of 0.05%. An investor can determine the expense ratio by dividing the annual expenses of the investment by the fund's total value, though the expense ratio is also typically found on the fund's website.
Why are ETF fees so low? ›
For most investors, ETF trades take place with other investors, and not with the fund company itself. That means the fund company doesn't have to process your order; doesn't have to mail you the same documents; and doesn't have to go into the market to process your order. Less work = lower costs.
What fees are charged by ETF? ›
ETF fees are operational expenses that are deducted from the fund assets. Therefore, investors do not pay fees directly to a fund manager. Since ETFs are traded on an exchange like stocks, they may also be subject to brokerage fees, which are commissions that are typically not more than $20 per trade.
What are the brokerage charges for ETFs? ›
Brokerage, STT, and Other Charges
The average brokerage charge on purchasing ETFs is 0.01% of the turnover value. There are certain charges that the SEBI levies on the purchase of stocks from an exchange. Since ETFs also trade like stocks and are listed on the exchange, ETFs attract such charges from SEBI.
How do ETFs pay out? ›
An ETF owns and manages a portfolio of assets. If those assets pay dividends or interest, the ETF distributes those payments to the ETF shareholders. Those distributions can take the form of reinvestments or cash. ETFs that position themselves as dividend funds generally opt for cash distributions over reinvestments.
What is the redemption fee for ETF? ›
The SEC generally limits redemption fees to 2% of the sales amount.
