What is a good total expense ratio

ETF costs - analysis and overview

ETFs are characterized by extremely low costs. But the popular saying “What costs little is worth little” definitely does not apply to the ETF industry. Due to the exact mapping of the indices on which the Exchange Traded Funds are based, there is no further activity in the portfolio and so there are no additional costs as with actively managed index funds.

Because there are no permanent reallocations, transaction costs are reduced to a minimum. The favorable total expense ratio (TER) results from the items issue surcharge, redemption fees and management fees. In addition, ETFs are characterized by low trading costs.

In addition, there is no one-off sales charge for the purchase of Exchange Traded Funds, nor is there a redemption fee for the sale. ETFs can generally be purchased very cheaply through direct banks. In general, the Total Expense Ratio (TER) provides information about the costs of an ETF. That's why investors like to look at the total expense ratio (TER) alone, but the bottom line is that the tracking difference also counts.

We have explained all these terms in detail below. We have analyzed the costs associated with different ETFs. You will also find the most important asset classes, regions and countries as well as a few statistics.

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Cost comparison: classic funds vs. ETFs

In the meantime, word has got around among most investors that ETFs are a far more cost-effective investment option, as passive index products require less administrative effort. In addition, numerous studies in the past have shown that actually only a few fund managers can sustainably beat the market. So why pay high management fees for their "effort" when you can do without?

As it is well known that an ETF maps a performance index as a special fund, the total cost burden can be determined directly from the difference between the index development and the ETF development. The associated transparency and the fact that ETFs are traded on the stock exchange (e.g. XETRA) and are free of commission make them a cost-effective alternative for investors.

All costs incurred in the total expense ratio

ETF management fees

Asset management fees apply to traditional investment funds. In the equities segment, these are around 0.8 to 2 percent annually. With ETFs, on the other hand, the management fees are very low due to the passive management style. In addition, there are no separate costs for the licenses or for the preparation of the prospectus. Changes in index weighting and dividend income management are free with ETFs.

The average management fees for ETFs on the German market are around 0.35 to 0.50% per year, and the trend is falling. The management fees for bond ETFs are as low as 0.15 to 0.25%. The fees are calculated pro rata for each day and automatically deducted from the fund assets. The administrative costs are also referred to as the total expense ratio (TER). The total expense ratio indicates the annual costs of a fund that are incurred in addition to the initial charge.

ETF trading costs

These costs, which are not included in the TER, include brokerage fees and the bid-ask spread. The difference between the buying and selling price can be compared with spreads as you know them with stocks. Very liquid ETFs show bid-ask spreads of a maximum of 0.05 percent on the stock exchanges. Overall, the trading margins for large, liquid indices are between 0.08 and 0.10 percent, but also reach over 0.5 percent for more specialized products.

The premium or discount to the net asset value is also a decisive factor. These costs can vary depending on the trading partner. In this respect, it is worthwhile to compare the prices and rates of several market participants, especially if the product is little traded or the volume of the order is low.

The time of trading also plays a role. Investors in Germany should start trading an ETF on the S&P 500 index from midday; when Wall Street is open, you get better conditions than if you place your order in the morning when the US stock exchanges are still closed.

Further costs of ETFs

In addition, customary exchange fees apply. These are around 0.02 to 0.08 percent. In addition, the settlement bank charges fees for the execution of an order. These are around 0.25 - 1 percent of the market value. The usual custody account fees of your bank or investment company will also be charged.

The custody fee is, inter alia, used for the administration of your ETF shares, the administration of tax exemption orders and the determination of the taxable interim profits. These costs are up to 1 percent and are usually negotiable. Most direct banks offer safe custody at no additional cost.

Tracking Error, Stock Lending & Replication Method

Anyone who opts for an ETF rightly expects two aspects: it should be cheap and, of course, it should reflect the index as precisely as possible. The total expense ratio, often abbreviated as TER, can be found out in no time for any ETF. However, that's only half the battle. Only in exceptional cases does an ETF replicate the index (what is an index?) Completely one-to-one. When trying to map, the ETF is usually a little below or above the index. Bankers refer to the deviation as the so-called tracking difference. If this assumes a negative value, that is good news for the investor. He outperformed the index. The main reason for this: securities lending. More on this below.

Tracking difference

First of all, the tracking difference: This includes all the implicit and explicit costs of investing in ETFs. By definition, ETFs lag behind their benchmark in terms of the TER. Suppose an investor invests in an ETF that tracks the EURO STOXX 50 index. The fund charges, purely hypothetically, 0.25% fees. In one year the EURO STOXX 50 index will rise by 10%. The return for the investor - after costs - is 9.75% (10% gross return of the benchmark minus the 0.25% fees). In this hypothetical example, the deviation from the target index corresponds exactly to the TER.

Tracking difference, ETF & benchmark return

The expense ratio is a predictable and easily quantifiable cause of the difference in performance between ETFs and their base indices. It is important to understand that ETF providers can offset some of the effects that fees have on the net return of ETFs with so-called "enhancements". So you spice up the return. This is usually done through stock lending, which generates additional income. In some cases, this extra income can more than offset the cost of the fund. As a result, the ETF can even outperform its benchmark. At the same time, however, this can also increase the counterparty risk. The higher return is offset by a higher risk.

Stock lending can reduce costs

These internal costs are only reduced by possible income from a securities loan. Depending on the management style of the ETF portfolio, fees may be added that depend on the respective tracking, the management of the cash assets within the fund, or the taxes that are due. For example, the fees incurred for a fully replicating ETF are significantly higher than for an optimized ETF that only has the most important underlyings in the index. The more liquid the market, the cheaper the mapping.

Different costs depending on the replication method

In order to calculate the total cost burden, there are internal and external cost factors that must be taken into account. These can be very different depending on the replication method. When the index is fully replicated, the rebalancing fee is charged in addition to the TER. Index providers such as S&P, MSCI and STOXX adjust the composition of their indices at regular intervals. In the case of physically replicating ETFs, the securities must be rebalanced or added or sold accordingly. This can result in additional costs or occasionally income.

Tracking Difference vs. Tracking Error

The investor should therefore differentiate between the tracking difference and the tracking error. As we just noted, the tracking difference is the difference between the performance of the ETF and its benchmark over a period of time. The tracking error, however, measures the performance volatility of the ETF relative to its benchmark. The standard deviation of the return difference between the ETF and the index is used to calculate the tracking error. This is based on a daily or weekly basis.

Dividends & Swap Fees

The timing of the distribution and the tax treatment of dividend payments are additional causes of potential problems with index tracking. The time difference between the ex-dividend day and the actual dividend payment can hurt the performance of distributing ETFs with physical replication. During this time, the amount to be distributed is held in an account that is separate from the fund. As a result, the investor will not have any outstanding dividends invested in the index during this period. This increases the risk that the ETF return will deviate from that of the index. The timing of the dividend payment has no effect on accumulating and swap-based ETFs (What is a swap ETF), as these ETFs remain 100% invested in the index at all times.

Dividends and the tax

The tax treatment of dividends is another important cost factor. As soon as ETFs receive dividends or coupons from countries in which a different tax system exists than in the ETF domicile, the withholding taxes can lead to an additional deviation from the index return. This withholding tax cannot always be reclaimed in full. ETFs with synthetic replication have advantages for some investor groups due to the more favorable tax treatment of dividends; so they may be better able to handle the withholding tax problem than physical replicating ETFs. (What are the different types of index mapping?)

Swap fees & the TER

In the case of synthetic replication via swaps, in addition to the TER and possible income from securities lending, the swap fees must also be taken into account in the calculation. This swap counterparty fee is payable under a swap agreement. The amount of the swap fee depends on the market segment of the fund and the agreement between the swap counterparty and the fund provider.

Costs for different assets or asset classes

Asset class costs

The costs of ETFs differ significantly in the asset classes. While bond and money market ETFs are available on average between 0.18% - 0.22% per year, the costs for equity ETFs are 0.38%. Real estate ETFs (0.42%), commodities (0.44%) and portfolio concepts (0.51%) are somewhat more expensive.

Costs for countries & regions

In the area of ​​equity-country ETFs, the range is 0.10% for Sweden ETFs to 0.96% for ETFs on the Indian equity market. It should be noted, however, that more expensive smart beta ETFs were also included. ETFs on the German stock market cost an average of 0.31%, with individual DAX ETFs being available from 0.10%. The same goes for the other countries. For example, an ETF on the S&P 500 Index is available for 0.07%, with the average for equity ETFs USA being 0.30%.

Equity sector costs

The range of stock sectors is also interesting. Favorable sectors include consumer goods (0.25%), luxury (0.25%), utilities and banks (0.28%), and health, industrial goods and construction for 0.29%. The more expensive sectors, on the other hand, include ETFs in the areas of infrastructure (0.78%), private equity (0.72%), water (0.63%), alternative energies (0.63%) and gold mines (0.57% ).

Costs for bond types

There are also clear differences in the area of ​​bond ETFs. While ETFs on Pfandbriefe and government bonds cost between 0.18% and 0.21%, ETFs on corporate bonds cost 0.25% and ETFs on convertible bonds even 0.73%. Taking the rating into account, ETFs on high-yield bonds even averaged 0.39%.

(Hidden) costs for commodity ETFs

Many ETCs and ETNs charge a number of other fees in addition to running costs. In the case of precious metal funds with physical deposits, this includes custody and storage fees, costs for the deposit of collateral and index license fees. The cost of depositing collateral reflects the cost of reducing counterparty risk for synthetic ETCs and ETNs. Research by Deutsche Bank has shown that these costs average 0.40% for ETCs and 0.23% for ETNs.

Deutsche Bank also estimates that index fees for ETC providers averaged 0.38% per year. These fees are rarely part of the total expense ratio and in some cases are not even mentioned in the fund documents. Investors should therefore be aware of possible hidden costs with ETFs.

Conclusion: Pay attention to the proportionality of all costs

In addition to the internal factors described, which differ depending on the replication method, external cost factors are also added to all ETFs. These are costs for the investor that are due at the time of buying or selling an ETF, such as trading fees such as the spread, broker fees, creation and redemption costs and taxes - e.g. B. Withholding tax in the fund, withholding tax on distributions by the fund, etc.

As already mentioned, the spread depends on various factors such as the liquidity of the underlying securities, the relationship between supply and demand, the fund volume or the number of market makers. Basically, the higher the liquidity of the ETF, the lower the costs. In order to calculate the actual costs for the entire holding period, you have to add up all the fees mentioned, minus any income that may be generated. And depending on the trading or stock exchange for ETFs, costs can in turn be saved.

In summary, it must be said: Although the actual costs of an ETF investment can be significantly higher than the total expense ratio (TER), ETFs are still a cheap investment in relation to the broader range of investments. Especially since many of the costs presented here are also incurred with actively managed funds and are not ETF-specific. Basically, one can say: The largest and most liquid ETFs are very cheap offers per se. In addition, there is an iron rule of thumb: the bottom line is that the tracking difference of the ETF product is more important than the TER (total expense ratio).