ETFs are among the cheapest investments you can make. They stand out in comparison to the funds sold by your bank due to the economies of scale and lack of management costs. But that doesn't mean there aren't any costs at all. We break them down so you can make a better judgment on what to look out for when choosing to invest in an ETF.
Cost of an ETF: the total expense ratio (TER)
The most important cost of an ETF is its total expense ratio, often abbreviated as TER. ETF managers charge a fee for managing their funds. A fund's total expenses are indicated by its total expense ratio. This includes management costs, administration costs and operational costs. The fund expresses the TER as a percentage of the total assets. For example, if an ETF manages 100 million euros and the costs are one million euros, the TER is 1%.
The impact of the TER on your return
The TER is automatically deducted from the price of the ETF and so from the fund's return. When you look at the return of a fund, you will already see the return after deducting the expenses. In any case, the expense ratio is crucial. It's a key figure to consider when choosing between different ETFs. This is because even small differences in TER can have a big impact over time, due to the power of compound interest. Saving a euro in fees boosts returns. Higher returns then make more returns for years. This snowball of higher returns is very impressive in the long run.
Cost of an ETF compared to an active fund
Compare these annual fees with your active fund or investment insurance, should you invest in them. Be sure to sit down first, as the differences are often huge. ETFs are 10 to 20 times cheaper than the active funds at your bank. You can find ETFs as low as 0.05% annual cost while banks sometimes dare to charge more than 2% on an annual basis for funds. You pay lower fees because index funds are very cheap to run. Tracking an index is simple. You buy the stocks in the index and update when it changes. It doesn't need expensive analysts or other specialists.
Let's consider the active fund KBC Equity Fund World (ISIN BE6213775529). It is offered by the large Belgian bank KBC. The fund costs 1.72% per year and uses the MSCI ACWI index as its benchmark. When we compare the fund's past performance to an ETF that tracks the MSCI ACWI, we see it has largely underperformed. We can speculate that the cost plays an important role in the underperformance.
The funds in the Curvo portfolios were chosen as to minimise ongoing fees. The average cost of the portfolios range from 0.17% for the Protective portfolio to 0.27% for the Growth portfolio.
Where to find the TER of an ETF
justETF.com is the best resource that we know to find information about ETFs. It shows all the important facts for the thousands of ETFs available in Europe. Below is what it shows for the popular IWDA ETF, and you can see that its TER is 0.20%.
You can also find the TER in the Key Investor Document (KID) of an ETF. It's a document that fund managers have to provide.
Other costs when investing in ETFs
Besides the TER, there are some other costs you may have to consider when you're investing in an ETF:
- Broker fees
- Taxes
- Bid-ask spread
- Cost of payment for order flow (PFOF)
Broker fees
You buy ETFs through a broker, which is a service that gives you access to the financial markets. Brokers charge a fee whenever you buy or sell an ETF. The fee varies considerably between brokers. For instance, to buy €1,000 of the IWDA ETF, the fee ranges from "free" to €14.95.
These fees are a reason why you shouldn't trade too frequently. It will make the broker happy, but it won't be good for the return on your investments.
Belgian investors can use our broker fee calculator to figure out the cheapest broker for any ETF.
Taxes
Taxes are also an important cost when investing in ETFs. In most countries, different ETFs will be taxed differently. So next to the total expense ratio, this plays an important role in selecting the right ETF for you.
For Belgium
There's a transaction tax (known as the "beurstaks" or "taxe sur les opérations de bourse" or TOB) every time you buy or sell an ETF. The tax rate varies between 0.12% and 1.32% of the transaction amount.
If you invested in a bond ETF that's accumulating, you'll have to pay the Reynders tax when selling. This is a tax on the capital gains. Lastly, the 30% dividend tax applies for distributing ETFs.
Find out all about the taxes when investing in Belgium.
For Italy
If you're an Italian investor, you'll have to pay a capital gain tax of 26% when you sell an ETF.
Bid-ask spread
The bid-ask spread is the difference between the highest price buyers are willing to pay (the bid) and the lowest price sellers are willing to accept (the ask). This spread affects the price at which you can buy or sell an ETF. A narrower spread suggests that the ETF can be traded easily without a significant impact on its price.
As long as you invest in funds that are large enough, you likely won't have to worry about the bid-ask spread. A good guideline is to invest in ETFs with more than €100m under management. You can find the size of an ETF on justETF.com.
Cost of payment for order flow (PFOF)
Brokers that use payment for order flow (PFOF) will also cause a higher spread, as they will route your order to the party that will earn them the highest revenue, rather than getting the best price for you. That's why this practice is being banned within the European Union.
Summary
In short, ETFs are very cost-effective which makes them our preferred type of investment. The total expense ratio (TER) is the most important cost. It is a factor to consider when selecting an ETF. But, also don't underestimate the impact of taxes. It's likely that some ETFs will be more tax-efficient for you than others. Lastly, the broker you choose has a big impact. They affect the extra fees you'll pay when you buy or sell an ETF. Remember that any fee negatively impacts your return.