Updated Wednesday, July 23, 2014 as of 3:57 PM ET
Do ETF Expense Ratios Matter?
Wednesday, May 28, 2014
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Everybody likes to get a good deal.

In the investment world, advisors regularly are pitched ETFs that save their clients a basis point or two compared with similar products. How much weight should those expense ratios carry?

“It’s always a consideration,” says Mark DiGiovanni, founder of Marathon Financial Strategies in Grayson, Ga. Even so, he says, “I can’t imagine too many situations where a one basis point difference is going to tip the scales one way or the other.” DiGiovanni says that other factors, such as the size of the ETF and the ease of buying and selling shares, are also important.

“One of the reasons many people have moved away from mutual funds to use ETFs is the cost savings,” says Roy Blumberg, a partner at Horatio Street Wealth Management in Malvern, Pa.

But Blumberg also adds caveats. He notes that moving from one ETF to another with a slightly lower expense ratio usually isn’t justified in a taxable account. And he cautions that similar-looking ETFs can be poles apart. Blumberg cites the example of two frontier, or “pre-emerging,” market ETFs that have “very different weightings,” resulting in a significant divergence in performance. “Make sure you’re getting the ETF that does what you want it to do,” he says.

Many advisors also consider an ETF’s bid-ask spread when buying or selling. But Blumberg says that should be a secondary consideration. “It becomes a little bit less of an issue for a long-term investor if you pay a penny or two more for something,” he says.

On the other hand, that expense ratio is always there. “You’re going to pay the management fee over and over again,” he adds. Blumberg says that lower ETF fees are part of the discussion he has with new clients. He tells them that a fee not paid is money going “right back into your pocket.”

Although DiGiovanni keeps expense ratios in mind when selecting investment products, he contends that saving a few basis points “isn’t really what we’re about. If you’re doing everything else, when you get down to that point, well that’s great.”

Over the long term, DiGiovanni says, it’s more important to create a proper asset allocation and to persuade the client to put enough money into savings every pay day. “Putting in 6% instead of 5% is going to do a lot more to get you to reach your goals than saving a couple of basis points on the expense ratio,” he says.

Joseph Lisanti, a Financial Planning contributing writer in New York, is a former editor-in-chief of Standard & Poor’s weekly investment advisory newsletter, The Outlook.

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(1) Comment
Interesting research last week found ETFs to be expensive relative to mutual funds when applied to 401(k) applications. This doesn't sound right to me, has anyone else come to that conclusion?

SCW

Posted by Stephen W | Wednesday, May 28 2014 at 3:51PM ET
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