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ETF Investing: Hidden Costs Passive Investors Need To Know About

Are ETFs really as cheap as they are made out to be?

In recent years, passive investing through Exchange Traded Funds (ETFs) have become increasingly popular among retail investors. For many new investors, ETFs make a lot of sense. Not only can investors start investing in ETFs even with limited knowledge, the investor also gains immediate diversification into the stock market at a low cost.

In fact, have written lots of article in the past about ETFs. From how ETFs investing really work in Singapore to why it makes sense for you to invest in the STI ETF.

However, contrary to popular thinking, ETF investing is not totally free.

Many passive investors ignore the fact that there is a cost they incur when they invest in ETF. The reason is because they don’t see the fee which they are paying. Rather, this fee is deducted off the net asset value (NAV) of the ETF.

Alternatively, some investors may be aware of the cost of investing in an ETF but may automatically assume that the cost is low. While this is generally true when compared to other active funds such as unit trusts, mutual funds or hedge funds, it’s nevertheless still a cost that will impact our investment bottom-line.

On their website, endowus wrote about the hidden cost of investing in ETFs. It’s a really interesting article and that got us thinking about what else extra you are paying when you invest in an ETF.

Annual Management Fee For ETFs

Many people (mistakenly) think of ETFs as similar to a stock, since both ETFs and stocks can be bought and sold on the stock exchange. In truth however, ETFs are open-ended investment funds.

What this means is that similar to most mutual funds and unit trusts that we invest in, there is a management fee that we pay when we invest in an ETF.

For example, if you purchase the Nikko AM STI ETF, you pay an annual management fee of 0.20% per annum (p.a).

Source: Nikko AM STI ETF

This fee is paid regardless of how well or how badly the ETF may have performed over the next 12 months. In other words, your ETF value has to grow by at least 0.2% per annum in order for you to break even each year.

According to an article from Wall Street Journal, the average ETF carries an expense ratio of 0.44%. This is in line with some of the other popular ETFs that we see in Singapore such as the Lion-Phillip S-REIT ETF (0.50% p.a.), the iShares MSCI India Index ETF (0.99% p.a.) and the SPDR Gold Shares (0.40% p.a.).

It’s also important to bear in mind that the annual management fee for your ETF is based on the net asset value (NAV) of the ETF, and not based on how much you actually invest into it. There is a stark difference between the two though newbie investors commonly lump together both thinking they are the same. They are not.

For example, if you invest $10,000 in an ETF that charges 1% p.a, and your fund grows by 8% per annum over the next 10 years, you would be paying a total of $2,043 in management expense over the 10-year period, or about $200 per year. This would represent about 20% of your total return.

Many people think that they are paying just $100 a year (1% of $10,000) but that’s only applicable if you hold your investment for just one year, and that your investment didn’t grow in value during the year.

Also, when you buy and sell ETFs, you are being charged a commission fee to the brokerage platform similar to what you pay when you buy and sell regular stocks. There is also a bid/ask spread that you should take note of.

Platform Fees When Investing Through Robo Advisors

Instead of investing into ETFs by buying them directly from the exchange, some investors may prefer to invest through a platform provider such as a robo advisor platform.

In Singapore, robo advisors typically charge between 0.2% to 1.0% p.a. for their service. In return, these robo advisors help you invest in an “optimal” portfolio which comprises of ETFs.

In other words, you will be paying two layers of fees. The first is the ETF management fee and the second is the robo advisor platform fee. If we assume that the ETF fee is 0.44% and the robo advisor platform fee is 0.6%, you are paying a total of 1.04% p.a.

Read Also: Robo Advisors in Singapore: What You Need To Know Before Investing

Robo advisors are far from the only platform that could charge you an additional fee for investing in an ETF. If you are investing in any ETF through a third-party service, chances are that you are paying an additional fee, on top of your usual ETF management fee.

ETFs That Invest Through Funds

If the ETF that you are investing in makes its investments through other funds, be careful of the fees stacking up.

Similar to investing in ETFs through a robo advisors, any ETF that exists as a vehicle to invest in other funds would implicitly bear some additional “hidden” cost.

For example, REIT ETFs have two layers of cost. The first layer of cost would be what’s paid to the ETF manager who created the REIT ETF. This would include the usual cost such as management fee, trustee fee, custodian fee and any other administration fee.

The second layer of cost is to the REIT manager itself. This would not explicitly be made known to you as an investor since the fee will be deducted from the actual returns delivered to the REIT ETF by the REIT. Essentially though, you are paying to both the 1) REIT manager and the 2) REIT ETF manager when you invest into a REIT ETF.

In other countries, there are also ETFs that invest its money into other ETFs. This is not common in Singapore (yet) but passive investors who enjoy investing in ETFs should take careful note of such ETFs.

Ensure That Your ETF Fees Are Worth The Returns They Deliver

This article isn’t meant to scare you off ETF investing. In fact, given the benefits that they deliver such as the immediate diversification they provide, and the ability for you to enjoy a hands-off investment approach at a minimal cost, many ETFs are worth considering.

However, savvy investors need to be aware of the cost that they are paying, regardless of how low it may appear to be. Many seemingly low cost (e.g. below 0.5% p.a.) that are tagged to ETFs can easily add up and compound itself over time. Hence, you should always ensure that the cost of an ETF which you are paying for is well worth the returns that it delivers to you.

Read Also: Step-By-Step Guide To Stock Investing In Singapore

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