Investors who buy into exchange-traded funds (ETFs) typically see lower fees than those charged for mutual funds. In 2022, the average expense ratio for an index ETF was 0.16%.The average cost for an actively managed mutual fund was 0.66%.Overall, the average fees for investors have seen a steady decline.
Key Takeaways
- Mutual fund companies have steadily cut their fees to compete with low-cost exchange-traded funds (ETFs).
- ETFs have lower costs on average than passively managed mutual funds and don't charge 12b-1 fees.
- The expense ratio is the cost of the mutual fund, including any management fees, fees for expenses, and 12b-1 fees, and expressed as a percentage of the total assets under management.
Mutual Fund Fees
The expense ratio is reported in every mutual fund prospectus, which details the costs to investors. The expense ratio is the total cost of the fund, including any management fees, fees for expenses, and 12b-1 fees. It is expressed as a percentage of the total assets under management. Mutual funds may include all or some of these fees:
- Management fees compensate those who trade the fund's portfolio.
- 12b-1 fees pay marketing costs and, sometimes, employee bonuses and cannot exceed 1% of the investor's assets.
- Account fees may apply to accounts that fall below a specified value.
- Redemption fees may be imposed to penalize short-term trading.
- Exchange fees may be charged for moving money between funds at the same company.
- Purchase fees may be levied at the time shares of a fund are bought.
The fee to purchase shares is the "load fee" paid to the broker or agent who sells the shares. This is a one-time charge, typically 5% of the amount invested. The legal maximum is 8.5%.Many "no-load" funds are available so investors can avoid this cost.
ETF Fees
Exchange-traded funds have costs, but they are not reflected in their statements. They are deducted daily from the net asset value of the fund. The administrative costs of managing ETFs are commonly lower than those for mutual funds.
Most ETFs are passively managed funds and always "no-load," meaning there is no purchase fee. Online brokers offer commission-free ETF trades. Unlike mutual funds, ETFs do not charge annual 12b-1 fees. These fees are advertising, marketing, and distribution costs that a mutual fund passes to its shareholders. Each investor pays for the fund company to acquire new shareholders.
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ETFs keep their administrative and operational expenses down through market-based trading. Because ETFs are bought and sold on the open market, the sale of shares from one investor to another does not affect the fund. The sale of ETF shares does not require the fund to liquidate its holdings or generate tax implications from capital gains, keeping costs to investors lower.
What Is the Difference Between an Actively or Passively Managed Mutual Fund?
An actively managed fund has a manager, or a team, devoted to buying and selling stock frequently. Their goal is to beat the performance of a particular benchmark index.
A passively managed fund is set up to mimic a specific benchmark index. No investing decisions are made. The only buying and selling are done to mirror changes in the index.
How Do Capital Gains Affect the Fees of Mutual Funds and ETFs?
When mutual fund shareholders sell shares, they redeem them from the fund directly. That often requires the fund to sell some assets to cover the redemption. When the fund sells off part of its portfolio, it generates a capital gains distribution to all shareholders. Mutual fund shareholders pay income taxes on those distributions, and the fund company handles transactions, increasing its operating expenses. Since the sale of ETF shares does not require the fund to liquidate its holdings, its costs are lower.
What Is In-Kind Redemption for an ETF?
ETFs use in-kind creation and redemption practices to keep costs down. Investors can trade a collection, or basket, of stock shares that match the fund's portfolio for an equivalent number of ETF shares. An investor can redeem shares by swapping them for an equivalent basket of stocks rather than selling them on the secondary market. The fund does not have to buy or sell securities to create or redeem shares, reducing the paperwork and operational expenses incurred by the fund.
The Bottom Line
Exchange-traded funds (ETFs) investors typically incur lower fees than those charged for mutual funds, and mutual fund companies have had to curtail fees to compete with low-cost ETFs. Most ETFs are passively managed funds, always "no-load," with lower operational, marketing and administrative costs passed to investors.
FAQs
ETFs have transparent and hidden fees as well—there are simply fewer of them, and they cost less. Mutual funds charge their shareholders for everything that goes on inside the fund, such as transaction fees, distribution charges, and transfer-agent costs.
Do all ETFs have higher management fees most mutual funds have lower fees? ›
The administrative costs of managing ETFs are commonly lower than those for mutual funds. ETFs keep their administrative and operational expenses down through market-based trading. Because ETFs are bought and sold on the open market, the sale of shares from one investor to another does not affect the fund.
What is the expense ratio of ETF when compared to mutual funds? ›
ETF expense ratios could be as low as 0.35%. An active mutual fund could have a total expense ratio of up to 2%. Expense ratios eat into the returns of funds, so the lower the expense ratio, the better.
What is the main difference between ETFs and mutual funds? ›
With a mutual fund, you buy and sell based on dollars, not market price or shares. And you can specify any dollar amount you want—down to the penny or as a nice round figure, like $3,000. With an ETF, you buy and sell based on market price—and you can only trade full shares.
How much are ETF fees? ›
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.
How much are mutual fund fees? ›
Mutual fund expense ratios are typically between 0.25% and 1% of your investment in the fund per year. Actively managed funds are usually more expensive than passively managed funds. Index funds and exchange-traded funds are typically the cheapest funds.
Which fund has the lowest management fee? ›
10 Best Low-Cost Index Funds to Buy
| Fund | Expense Ratio |
|---|
| Fidelity ZERO Large Cap Index Fund (FNILX) | 0% |
| Vanguard S&P 500 ETF (VOO) | 0.03% |
| iShares Core U.S. Aggregate Bond ETF (AGG) | 0.03% |
| Schwab 1000 Index Fund (SNXFX) | 0.05% |
6 more rowsApr 29, 2024
ETFs typically have lower expense ratios than mutual funds because they offer minimal shareholder services. Though mutual funds may be slightly more costly, fund managers provide support services.
Why are mutual fund fees so high? ›
1. Active management: Mutual funds employ fund managers who actively select securities, requiring research, analysis, and trading costs. 2. Operating expenses: Mutual funds have higher operating expenses, such as administrative costs, marketing expenses, and shareholder reporting.
What expense ratio is too high for ETF? ›
How to find the best ETF expense ratio. High fees can turn any investment into a poor one. A good rule of thumb is to not invest in any fund with an expense ratio higher than 1% since many ETFs have expense ratios that are much lower. Also, ETFs tend to be passively managed, which keeps the management fee low.
“Asset managers often set ETF fees at similar levels as the cheapest share classes of mutual fund strategies, sometimes cheaper,” the report said. “This is partly why the average active ETF fee (0.65%) is 36% cheaper than the average active mutual fund. ETFs also don't have sales loads or 12b-1 fees.”
What are some of the arguments for why an ETF is better than a mutual fund? ›
Key Takeaways. Many mutual funds are actively managed while most ETFs are passive investments that track the performance of a particular index. ETFs can be more tax-efficient than actively managed funds due to their lower turnover and fewer transactions that produce capital gains.
Why do people choose mutual funds over ETFs? ›
As we covered earlier, infrequently traded ETFs could have wide bid/ask spreads, meaning the cost of trading shares of the ETF could be high. Mutual funds, by contrast, always trade without any bid-ask spreads.
What are the disadvantages of ETFs compared to mutual funds? ›
Disadvantages of ETFs. Although ETFs are generally cheaper than other lower-risk investment options (such as mutual funds) they are not free. ETFs are traded on the stock exchange like an individual stock, which means that investors may have to pay a real or virtual broker in order to facilitate the trade.
Are ETFs more tax efficient than mutual funds? ›
Although similar to mutual funds, equity ETFs are generally more tax-efficient because they tend not to distribute a lot of capital gains.
Are ETFs taxed differently than mutual funds? ›
ETFs are generally considered more tax-efficient than mutual funds, owing to the fact that they typically have fewer capital gains distributions. However, they still have tax implications you must consider, both when creating your portfolio as well as when timing the sale of an ETF you hold.
What are three disadvantages to owning an ETF over a mutual fund? ›
Disadvantages of ETFs
- Trading fees. Although ETFs are generally cheaper than other lower-risk investment options (such as mutual funds) they are not free. ...
- Operating expenses. ...
- Low trading volume. ...
- Tracking errors. ...
- The possibility of less diversification. ...
- Hidden risks. ...
- Lack of liquidity. ...
- Capital gains distributions.
ETFs often generate fewer capital gains for investors than mutual funds. This is partly because so many of them are passively managed and don't change their holdings that often.
