This past week a major provider of index funds dropped their fees to a record low level. The provider, Blackrock, which markets the I Share funds dropped their fees to .03% on their total market stock fund.
In addition fees were dropped on a number of other products. Most likely other providers will either match, or come close to matching this new fee level.
To give an example of how low this fee is, on a $10,000 investment the annual cost would just be $3. For an actively managed mutual fund, a typical cost would be 1% per year, or $100 for the $10,000 investment.
The new fees are on Exchange Traded Funds, commonly referred to as ETF’s. An ETF trades like a stock, so someone would need to have a brokerage account in place to be able to purchase an ETF.
For those who do not wish to have a brokerage account index related products can be purchased through a mutual fund. The fee structure on an index related mutual fund is similar to an ETF. A mutual fund can only be bought and sold at the end of a trading day, while an ETF can be bought anytime when the market is open.
Purchasing an ETF does incur a brokerage commission, which for a discount broker is typically $5 to $10. A mutual fund would not have any cost to purchase or sell, as long as it is a no load fund. Some mutual funds may have restrictions, in that they have to be held for a certain period of time, whereas for ETF’s that is not applicable.
In an extremely volatile market an ETF may not always trade exactly with its underlying assets, whereas a mutual fund is priced in accordance with its holdings.
An ETF does offer more flexibility versus a mutual fund, especially for those who are likely to trade more frequently. However, for most investors frequent trading is not something I would typically recommend.
For the average investor convenience would be a major factor in whether to use an ETF versus a mutual fund. If someone already has a brokerage account in place, using ETF’s would be simpler versus having a separate account for mutual funds. Likewise, for someone who doesn’t have a brokerage account purchasing mutual funds would be easier.
Nonetheless, there is nothing wrong if someone has an additional account, if they have a strong preference either way for a mutual fund or ETF.
When purchasing ETF’s, or mutual funds there are a wide array of choices. For someone’s main investment in stocks the choices would be a total market fund, or an S&P 500 based fund. The total market fund has its largest weighting in large companies, but has some exposure to small and mid-sized ones. The S&P 500 fund will be invested just in large corporations.
The total market fund will likely provide a little greater performance over time versus the S&P 500 fund because of its exposure to riskier small and mid-sized companies. In bad markets the S&P 500 fund would normally decline less. The total market fund provides investors with different categories of investments with just one fund. However, for some investors a more custom tailored approach might be preferable, which would necessitate using several stock based funds.
With regards to expenses, the total market and S&P 500 have the lowest fees. These fees would normally be .03 to .07%. Other stock based index funds, such as small, mid-sized, and international would generally have fees in the 1 to 2% range. Fees for index related bond funds would be fairly similar to the stock based funds.
For those investing in a 401K plan at work it is always important to know the fees of your fund choices. Depending upon the employer, the options and the fees will vary. If there is an option for an index fund, it will have a significantly lower fee versus an actively managed product.
The fees for employer based index funds may not be as low, as the ones I have quoted, but still should be relatively low.
I am not necessarily implying all actively managed funds with higher fees are poor choices. However, over long periods of time most index funds do provide greater returns versus actively managed ones. Just because one fund may have outperformed over the prior five years does not mean it will do so again in the future.
That is why for most investors going with the lower cost products is the preferable option, since it is very difficult to determine which fund managers will be the best performers in the future.