If an ETF is index-based, investors should check to see how closely the fund follows its underlying index. Often, an ETF’s index tracking error will be tiny, perhaps only a few tenths of one percent.
How well or poorly an ETF follows its index is dependent on many factors, including the manager’s fees and skills. New ETFs that are promoted as zero-fee funds lack a performance and fee history, making it impossible to gauge their tracking error.
Fee Stability
While trailblazing ETFs are promoting their wares as no-fee (or pay-to-own), the reality is the fees are merely being temporarily waived and that investors will start paying full freight after the fee waivers expire.
A more prudent approach for advisors could be to stick with ETF providers that have a history of fee stability, rather than jumping to whatever new ETFs are making juicy but temporary promises of zero-cost products. While certain ETF providers might not have the absolute lowest expense ratios, their ability to consistently reduce and minimize total ownership costs can make funds from these companies an excellent choice.
Summary
In the end, expense ratios still matter. A recent study by Brown Brothers Harriman, in partnership with ETF.com, surveyed 300 institutional investors, financial advisors and fund managers from around the world. Among U.S.-based professionals, expense ratios were the number one criteria when selecting an ETF, followed by index methodology and historical performance.
Nevertheless, informed advisors know that expense ratios aren’t the only cost associated with ETF investing, and that less obvious costs could be lurking inside zero-fee ETFs.
Ron DeLegge is founder and chief portfolio strategist at ETFguide.