What To Expect
Typically, large-cap or broad U.S. index-based ETFs will have the lowest expenses, since it's easy to replicate these types of indices. Thus the cheapest ETFs on the market, those with 0.05% expense ratios, cover broad markets, for example, the FocusShares Morningstar Large Cap Index ETF (FLG), the FocusShares Morningstar U.S. Market Index ETF (FMU) and the Vanguard S&P 500 ETF (VOO).
However, once investors move down to more specialized funds, they should expect higher costs, since indexing replication becomes harder and costlier when managers move beyond the traditional asset classes and styles. It's notoriously less efficient, for instance, to get exposure to emerging countries and their comparatively illiquid markets. The average expense ratios on the most recent ETF launches have been slightly higher at 0.6%, which reflects the providers' expansion into areas such as emerging market bonds and other international offerings.
The costliest funds in the ETF space have emerged in the up-and-coming actively managed ETF space. Since these funds have managers who carefully guide them, they will naturally charge higher management fees.
Commission-Free Trades
If we trace the ETF price war to its beginning, we may find that Charles Schwab instigated it. The brokerage firm first offered investors free trades on Schwab ETFs for those with in-house accounts, and before long, many other providers and custodians followed suit.
Choosing lower expense ratios is not the only way to save on overall costs. Investors may also look to see if their brokerage platforms offer free trades on select ETFs. For instance, individuals browsing for lists of ETFs available for commission-free trading on a trading platform can look for lists from Charles Schwab, E*Trade, Fidelity, Firstrade, Interactive Brokers, Scottrade, TD Ameritrade and Vanguard.
Both expense ratio and commission-free cost considerations should be tied to a person's investment horizon. If an investor plans to hold an ETF for a long time, low expense ratios may be better, since the lower annual cost will help keep returns in the investor's pocket. However, if an investor uses an ETF to hedge short-term positions or engage in frequent or quick market trades, the brokerage commission fees can rack up. In that case, commission-free ETF trades may be the better option.
Nevertheless, while costs are an important factor, investors must also look at an ETF's investment potential. Just because it is the cheapest does not mean it is the best choice for your portfolio.