Investors today have the blessing of being on the winning side of a secular, decades-long decline in fund fees. Several trends have played into this, including:
- Massive inflows to stocks as a whole, but specifically out of mutual funds and into ETFs ($7 trillion and counting in just the past decade!). As more assets flow into more ETFs, their fixed costs become a smaller proportion of overall costs
- Competition among fund providers as the financial services space sees new entrants and a relaxed regulatory environment.
- Commission rates for buying stocks moving towards $0. This reduces ongoing expenses of the fund operator, allowing them to pass on some cost savings to fund holders.
Avoid the traps
While that’s all well and good, many investors fall into the trap of just buying into the largest funds (as measured by assets under management, AUM) or the ones that have the best performance. Or maybe they put too much value on the fund who was first to market, thinking there’s some inherent advantage to being the first mover. These are traps because many of the largest and oldest funds in each space of the market don’t have the lowest expense ratios – despite not offering any discernible advantage over competing funds.
In most cases we’re talking about small savings that can be found – a few basis points (1/100th of a percent) here, a few basis points there… but these things add up fast, as we’ll show you at the end of this article. Let’s go through a few relevant examples from our own investing arsenal, to highlight the benefits of doing some extra digging when making key portfolio choices.
Going for Gold – GLD vs IAU
SPDR Gold Shares (GLD) was the first ETF to come to market that just held gold bullion, and nothing more. It began trading in 2004, and it’s now the largest gold ETF, with over $60 billion in AUM. It carries an expense ratio of 0.40% per year ($40 per $10,000 invested).
It’s smaller peer, IAU, the iShares Gold Trust, came to market just one year later, and does the exact same thing as GLD, simply holding gold bullion in storage and aiming to track the underlying price of the metal as closely as possible. IAU has just shy of $30 billion in AUM, and has an expense ratio of 0.25% per year, or $15 less per $10,000 invested.
IAU and GLD are basically the exact same fund, but one is cheaper. If you’re looking to invest in gold for its various diversification benefits consider going with IAU over GLD.
VOO vs SPY: Vanilla vs Vanilla
There are literally hundreds of ETFs with the sole purpose of tracking the S&P 500 index. That’s it. Pretty simple. That’s why the expense ratios are low across the board for S&P 500 trackers – competition and simplicity. SPY, the SPDR S&P 500 ETF Trust, is far & away the largest fund in the space, and one of the very first ETFs anywhere, coming to market in 1993. SPY now has over $350 billion under management, and charges just 0.095% per year in expenses.
But alas, VOO, the Vanguard S&P 500 ETF, with its meager (sic) $240 billion in AUM, does it even better at just 0.03% per year. We’ll happily choose Vanguard’s vanilla here.
POTX vs MJ – Cannabis Competitors
Costs are higher here even though these are all-stock funds, as the young cannabis space has many of its key companies located abroad in Canada and elsewhere. This makes it more costly for the fund operator to trade shares, and they typically trade with less liquidity and higher volatility than a stock in the S&P 500.
MJ had the first-mover advantage here, with an inception date of 2015. MJ has an expense ratio of 0.75% and a healthy $1.5 billion in AUM. Because the cannabis industry doesn’t have that many listed stocks as of yet, the fund is rather concentrated in its holdings.
The same is true for POTX, which has $183 million in AUM and came to market a few years after MJ. Despite a heavy overlap in the holdings of the two funds, POTX charges 0.51% per year, and we are once again happy to book some savings for our clients who have expressed interest in the cannabis space.
VGLT vs TLT – Battle of the Bonds
The iShares 20+ Year Treasury Bond ETF, or TLT, is one the largest treasury bond ETFs in the market, with over $15 billion in AUM. It’s been around since 2002, and charges an affordable 0.15% per year despite the extra costs of transacting in individual treasury bonds.
But VGLT, Vanguard’s Long-Term Treasury ETF, holds the exact same portfolio dimensions and charges just 0.05% per year.
A Buck Here, a Buck There, and Pretty Soon…
If we add up the total cost savings we get from these four examples, we get to:
0.15% + 0.065% + 0.24% + 0.10% = 0.52% in total savings.
Consider the application of these numbers on a hypothetical $100,000 portfolio (yearly savings vs competitor):
- $60,000 invested in VOO ($39)
- $25,000 invested in VGLT ($25)
- $10,000 invested in IAU ($15)
- $5,000 invested in POTX ($12)
That’s $91 in savings per year, or an extra 9 basis points in performance each year. $91 isn’t a lot of money, but it’s basically free money. You’re not doing anything to earn that extra money, other than comparing two funds that do the exact same thing, and choosing to buy the one that has a lower expense ratio.
Furthermore, if we take that extra 9 basis points in performance and consider how it can compound, our savings grow! After 10 years, we’re not just saving $910 on this portfolio, we’ve earned more because our savings compounded at a higher rate than had we chosen competing, higher cost, ETFs.
Let’s say the competing portfolio returns 7% per year over 10 years, that would mean our portfolio, holding nearly identical, but lower cost, ETFs, returns 7.09% per year over those same 10 years. After ten years, our profit is $1,395 greater than the competing portfolio. After 20 years, our profit is $5,800 greater! And if we’re talking a $1 million portfolio and not $100,000, the extra profits increase to $13,900 (after 10 years) and $58,000 (after 20 years)!! Again, this is basically free money. These funds are essentially identical and will perform extremely similar over time.
So the next time you are evaluating an index ETF, make sure you research if there is a competing ETF out there that might be a little cheaper. Those savings can add up and increase the rate of return on your investments. Two great resources for comparing ETFs are ETFDB.com and ETF.com.
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