Total Costs of ETF Ownership
The main three costs of holding an ETF include the commission, the spread, and the annual management fee.
Given that ETFs tend to have large asset sizes and trade in blocks, how would you expect ETF commissions to compare to the average?
Yes. Trading in blocks is more efficient and it leads to a lower commission rate. Often, that's just a few basis points.
No, it shouldn't be higher. Consider the relative efficiency of trading in blocks.
Those commissions can add up, but it depends on the holding period. For what investment horizon would you expect commissions to have a higher impact?
Definitely.
No, long-term holding periods see that commission spread out and its impact lessened. But short-term holdings will see a higher impact of commissions.
It's the same for the bid–ask spread. It's a purchase-and-sale cost, but it matters less if you are holding the ETF for five years than if you're holding for five months. Would you expect the same for an annual fee?
No, an annual fee for five years would be paid five times.
You got it!
How would you expect the sale cost to compare?
Yes.
That's the "round trip" cost: commission and half the spread on the way in, and commission and the other half of the spread on the way out.
Probably not; there's really no reason to expect the sale cost to be lower.
Probably not; there's really no reason to expect the sale cost to be higher.
Then there's the annual management fee; suppose it's 0.28% per year. Then you would need to scale it for the number of months in your holding period. A four-month holding period would lead to a total cost of:
>$$ 0.04 \% \times 2 + 0.16 \% + \frac{4}{12}(0.28 \% ) = 0.33 \% $$.
Following this same logic, what would the five-year holding cost be as a percentage?
Exactly!
Not quite.
In this case, the holding period cost is:
>$$ 0.04 \% \times 2 + 0.16 \% + \frac{60}{12}(0.28 \% ) = 1.64 \% $$.
While trading costs were the majority of the holding period cost for the short-term investor, these play a minor role over the long term, where the annual management fee dominates the holding period cost.
To summarize:
[[summary]]
Long-term investors will be more concerned about the annual management fee, since that will be most of the holding period cost over many years. For example, if you pay a USD 12 commission on a USD 30,000 purchase, that's four basis points. Then you might have a bid–ask spread that's 16 basis points wide, so you pay half of that as well. That's a cost of 12bp to make the purchase.
Actually, there should be a clear difference due to the relative efficiency of trading in blocks.
Lower
Higher
Short-term
Long-term
Yes
No
Equal
Lower
Higher
Other responses
1.64
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Approximately equal
