Investors who buy into exchange-traded funds (ETFs) typically see lower fees than those charged for mutual funds. In 2022, the average expense ratio for an index ETF was 0.16%.The average cost for an actively managed mutual fund was 0.66%.Overall, the average fees for investors have seen a steady decline.
Key Takeaways
- Mutual fund companies have steadily cut their fees to compete with low-cost exchange-traded funds (ETFs).
- ETFs have lower costs on average than passively managed mutual funds and don't charge 12b-1 fees.
- The expense ratio is the cost of the mutual fund, including any management fees, fees for expenses, and 12b-1 fees, and expressed as a percentage of the total assets under management.
Mutual Fund Fees
The expense ratio is reported in every mutual fund prospectus, which details the costs to investors. The expense ratio is the total cost of the fund, including any management fees, fees for expenses, and 12b-1 fees. It is expressed as a percentage of the total assets under management. Mutual funds may include all or some of these fees:
- Management fees compensate those who trade the fund's portfolio.
- 12b-1 fees pay marketing costs and, sometimes, employee bonuses and cannot exceed 1% of the investor's assets.
- Account fees may apply to accounts that fall below a specified value.
- Redemption fees may be imposed to penalize short-term trading.
- Exchange fees may be charged for moving money between funds at the same company.
- Purchase fees may be levied at the time shares of a fund are bought.
The fee to purchase shares is the "load fee" paid to the broker or agent who sells the shares. This is a one-time charge, typically 5% of the amount invested. The legal maximum is 8.5%.Many "no-load" funds are available so investors can avoid this cost.
ETF Fees
Exchange-traded funds have costs, but they are not reflected in their statements. They are deducted daily from the net asset value of the fund. The administrative costs of managing ETFs are commonly lower than those for mutual funds.
Most ETFs are passively managed funds and always "no-load," meaning there is no purchase fee. Online brokers offer commission-free ETF trades. Unlike mutual funds, ETFs do not charge annual 12b-1 fees. These fees are advertising, marketing, and distribution costs that a mutual fund passes to its shareholders. Each investor pays for the fund company to acquire new shareholders.
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ETFs keep their administrative and operational expenses down through market-based trading. Because ETFs are bought and sold on the open market, the sale of shares from one investor to another does not affect the fund. The sale of ETF shares does not require the fund to liquidate its holdings or generate tax implications from capital gains, keeping costs to investors lower.
What Is the Difference Between an Actively or Passively Managed Mutual Fund?
An actively managed fund has a manager, or a team, devoted to buying and selling stock frequently. Their goal is to beat the performance of a particular benchmark index.
A passively managed fund is set up to mimic a specific benchmark index. No investing decisions are made. The only buying and selling are done to mirror changes in the index.
How Do Capital Gains Affect the Fees of Mutual Funds and ETFs?
When mutual fund shareholders sell shares, they redeem them from the fund directly. That often requires the fund to sell some assets to cover the redemption. When the fund sells off part of its portfolio, it generates a capital gains distribution to all shareholders. Mutual fund shareholders pay income taxes on those distributions, and the fund company handles transactions, increasing its operating expenses. Since the sale of ETF shares does not require the fund to liquidate its holdings, its costs are lower.
What Is In-Kind Redemption for an ETF?
ETFs use in-kind creation and redemption practices to keep costs down. Investors can trade a collection, or basket, of stock shares that match the fund's portfolio for an equivalent number of ETF shares. An investor can redeem shares by swapping them for an equivalent basket of stocks rather than selling them on the secondary market. The fund does not have to buy or sell securities to create or redeem shares, reducing the paperwork and operational expenses incurred by the fund.
The Bottom Line
Exchange-traded funds (ETFs) investors typically incur lower fees than those charged for mutual funds, and mutual fund companies have had to curtail fees to compete with low-cost ETFs. Most ETFs are passively managed funds, always "no-load," with lower operational, marketing and administrative costs passed to investors.
FAQs
ETFs have transparent and hidden fees as well—there are simply fewer of them, and they cost less. Mutual funds charge their shareholders for everything that goes on inside the fund, such as transaction fees, distribution charges, and transfer-agent costs.
Do ETFs have higher fees than mutual funds? ›
For example, in 2022 an average mutual fund (asset-weighted) would cost 0.44 percent of your assets each year. In practical terms, it would cost $44 for every $10,000 you have invested. In contrast, the comparable average ETF has an expense ratio of just 0.16 percent, or $16 annually for every $10,000 invested.
How are ETFs taxed compared to mutual funds? ›
ETFs are generally considered more tax-efficient than mutual funds, owing to the fact that they typically have fewer capital gains distributions. However, they still have tax implications you must consider, both when creating your portfolio as well as when timing the sale of an ETF you hold.
What is the average fee for ETF funds? ›
Trading commissions
Also known as ETF transaction fees or ETF transaction costs, these may range from $8 to $30 at brokerage firms. Trading commissions are charged per trade, so they can add up if investors buy and sell a lot—and they're usually more expensive when an order is placed in person or over the phone.
Why are active ETFs cheaper than mutual funds? ›
The structure of an actively managed ETF can enable it to have lower expenses vs. a comparable mutual fund. Tax efficiency. The share creation and redemption process can possibly result in ETFs being more tax-efficient than a comparable mutual fund because the process is done "in-kind," which is not a taxable event.
Why choose an ETF over a mutual fund? ›
ETFs usually have to disclose their holdings, so investors are rarely left in the dark about what they hold. This transparency can help you react to changes in holdings. Mutual funds typically disclose their holdings less frequently, making it more difficult for investors to gauge precisely what is in their portfolios.
What are three disadvantages to owning an ETF over a mutual fund? ›
Disadvantages of ETFs
- Trading fees. Although ETFs are generally cheaper than other lower-risk investment options (such as mutual funds) they are not free. ...
- Operating expenses. ...
- Low trading volume. ...
- Tracking errors. ...
- The possibility of less diversification. ...
- Hidden risks. ...
- Lack of liquidity. ...
- Capital gains distributions.
ETFs don't often have large fees that are associated with some mutual funds. But because ETFs are traded like stocks, you may pay a commission to buy and sell them, although there are commission-free ETFs in the market. To be fair, mutual funds do offer a low cost alternative: the no-load fund.
How to avoid capital gains tax on ETF? ›
One common strategy is to close out positions that have losses before their one-year anniversary. You then keep positions that have gains for more than one year. This way, your gains receive long-term capital gains treatment, lowering your tax liability.
Are ETF fees tax deductible? ›
However, like fees on mutual fund, those paid on ETFs are indirectly tax deductible because they reduce the net income flowed through to ETF investors to report on their tax returns. Other non-deductible expenses include: Interest on money borrowed to invest in investments that can only earn capital gains.
How to find the best ETF expense ratio. High fees can turn any investment into a poor one. A good rule of thumb is to not invest in any fund with an expense ratio higher than 1% since many ETFs have expense ratios that are much lower. Also, ETFs tend to be passively managed, which keeps the management fee low.
How much does Fidelity charge for ETF? ›
$0.00 commission applies to online U.S. equity trades, exchange-traded funds (ETFs) and options (+ $ 0.65 per contract fee) in a Fidelity retail account only for Fidelity Brokerage Services LLC retail clients. Sell orders are subject to an activity assessment fee (from $0.01 to $0.03 per $1,000 of principal).
How much are mutual fund fees? ›
The asset-weighted OER ratio for passively managed mutual funds is 0.05%. OERs can range from 0.02% – 0.39%. The asset-weighted OER ratio for actively managed mutual funds is 0.76%. OERs can range from 0.38% – 1.09%.
Do ETFs typically have lower fees than mutual funds? ›
The administrative costs of managing ETFs are commonly lower than those for mutual funds. ETFs keep their administrative and operational expenses down through market-based trading. Because ETFs are bought and sold on the open market, the sale of shares from one investor to another does not affect the fund.
Why are ETF prices more volatile than mutual funds? ›
Like stock share prices, ETF share prices continuously change daily based on trading market volume. This makes ETFs more volatile than mutual funds. On the other hand, mutual fund prices are only set once per day after the markets have closed.
Should I invest in VFIAx or Voo? ›
Investors who prefer to trade during the day to take advantage of price fluctuations may prefer an ETF like VOO, whereas a more passive buy-and-hold investor may prefer a mutual fund like VFIAX. Investors using a taxable brokerage account may prefer VOO because tax implications are another important factor to consider.
Why are ETFs more expensive? ›
The most obvious is the operating expense ratio (OER), which is incurred while owning the ETF. However, trading costs are also important: Commissions (if applicable), bid/ask spreads, and changes in discounts and premiums to an ETF's net asset value (NAV) will impact the total cost of ownership.
What is the biggest advantage of an ETF over other funds? ›
ETFs have several advantages for investors considering this vehicle. The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs versus like mutual funds, and potential tax benefits.
Do you pay taxes on ETFs if you don't sell? ›
At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.
Do mutual funds have higher fees than index funds? ›
Active mutual funds typically have higher fees than index funds. Index fund performance is relatively predictable; active mutual fund performance tends to be less so.
