How are ETF fees deducted?


Investment management fees for exchange traded funds (ETFs) and mutual funds are deducted by the ETF or fund company, and adjustments are made to the net asset value (NAV) of the fund on a daily basis. Investors don’t see these fees on their statements because the fund company handles them in-house.

Management fees are just a component of the total management expense ratio (MER), which is what should concern investors.

Key Takeaways

  • Management fees reduce the value of an ETF investment.
  • They are a subset of the total “management expense ratio.”
  • MERs are generally lower for passive funds than for active.

ETF Fees

As part of its normal operations, an ETF company incurs expenses ranging from manager salaries to custodial services and marketing costs, which are subtracted from the NAV.

Assume an ETF has a stated annual expense ratio of 0.75%. On an investment of $50,000, the expected expense to be paid over the course of the year is $375. If the ETF returned precisely 0% for the year, the investor would slowly see his $50,000 move to a value of $49,625 over the course of the year.

The net return the investor receives from the ETF is based on the total return the fund actually earned minus the stated expense ratio. If the ETF returns 15%, the NAV would increase by 14.25%. This is the total return minus the expense ratio.

The Impact of Fund Expenses

Fees are important because they can have a huge impact on your ultimate returns. A $100 investment that grows by 7% a year would be worth $197 in 10 years, without fees. Subtract a 1% annual fee, though, and the result is $179, meaning fund expenses have eaten up 10% of your potential portfolio. Because fees compound over time, just like portfolio assets, the longer the investing period, the bigger the loss.

Ways to Minimize Expenses

Fees have generally come down in recent years, but some funds are nonetheless more expensive than others. A critical distinction here is passive vs. active management.

Passive managers simply mimic the holdings of a stock index, often the S&P 500, sometimes with minor deviations. These “index fund” or “index ETF” managers periodically rebalance fund assets to match the benchmark index, and this, in turn, incurs trading costs, but they are usually minimal.

Active managers, as the name suggests, take a greater hand in choosing fund assets. This requires, among other things, expensive research departments that passive funds don’t, and usually a higher level of trading, which elevates transaction costs. All of this gets reflected in the MER.

In 2018, fees at U.S.-registered active funds averaged 0.67%, as against 0.15% for passive funds, according to Morningstar, a widely consulted source of fund data.

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