As a new investor, you might be wondering: what is a good net expense ratio for an ETF? For an index fund ETF, a good net expense ratio is generally below 0.10%. For an actively managed ETF, a good net expense ratio is generally below 0.6%. Let’s break this down in more detail!
As a quick note – this only relates to ETFs investing in stocks, not bonds or any other investments!
What is a Net Expense Ratio?
A net expense ratio of an ETF is the expense percentage charged by the fund managers to investors. Let’s say you make a $1,000 investment in an ETF and the expense ratio is 0.10%. That means, every year, the fund managers collect 0.10% * 1,000 = $1 from you.
The fund managers are compensated for administering the fund, picking the investments, the legal work, etc.
Why Are Some Expense Ratios Higher Than Others?
There are a few reasons you’ll see higher expense ratios for certain ETFs versus others.
Active vs. Passively Managed
First, and most commonly, expense ratios may be higher for some ETFs as they are actively managed. This means that the fund managers are directly determining the fund’s stocks, rather than an index deciding them. This means they likely have to hire more analysts, do more research, etc. which costs more. Nothing in this world is free, so that cost is generally passed on to investors via the expense ratio!
Passively managed funds, conversely, do not determine their investments themselves. They base them entirely off of an index that someone else creates. A perfect example of this is the S&P 500 and associated index funds. Standard & Poors (S&P) create and maintain the S&P 500 index. So S&P 500 index funds just pick whatever they say goes into it. No need for stock picking, analysis, etc. Simple enough! Therefore, the expenses on these funds are generally lower.
Branding
Just like with off-brands or name brands at the super market, some ETFs tracking the exact same indexes charge more than others? Why is that? Sometimes, it’s due to the branding of the ETF. Take the biggest index fund ETF as an example: SPY. SPY’s net expense ratio is 0.09%, whereas competitors like IVV and VOO are only 0.03%.
Then how is SPY the largest S&P 500 index fund? Mostly, because they have branded themselves as the superior index fund! This has also brought increased liquidity and the easiest S&P 500 index fund to trade options on.
So if you don’t care about any of that, grab a lower cost S&P 500 index fund and reap those sweet sweet additional gains!
What Is A Good Net Expense Ratio For An ETF?
Now that we have some background, let’s come back to the original question. What is a good net expense ratio for an ETF? Let’s break this down.
What is a Good Net Expense Ratio for a Passively Managed ETF?
The three largest (by net assets) ETFs tracking an index are SPY, IVV, and VOO. SPY’s net expense ratio is 0.09%, whereas (and not surprisingly) VOO and IVV’s net expense ratios are the same at 0.03%.
SPY is easily the most well-known and most invested-in ETF tracking an index fund. So I would NEVER suggest investing in a stock-based index ETF higher than SPY. Therefore, the maximum net expense ratio for a passively managed ETF you consider should be 0.10%.
What is a Good Net Expense Ratio for an Actively Managed ETF?
This one gets tricky. There are actively managed funds that perform well and maintain expense ratios well over 1.0%. However, for an actively managed ETF, I would only consider a net expense ratio generally below 0.6%. Here’s why.
First, as a note on active management. Some people may consider that a higher net expense ratio means you’re getting better analysis, and therefore better returns. History has shown that this is rarely true. So I generally do not recommend actively managed ETFs for stocks. But if you must delve into this world…
Many of the lower cost fund managers like Vanguard and Fidelity have their own actively managed funds for stocks. Taking Fidelity as the example, their highest net expense ratio actively managed ETF is FBCG (FIDELITY® BLUE CHIP GROWTH ETF). FBCG’s net expense ratio is 0.59%.
Based on this, if you can get active management for large cap stocks for 0.59%, I would not pay extra for other fund managers to do something similar. Therefore, I would only consider a net expense ratio generally below 0.6%.
Bottom Line
We’ve seen why some ETFs have higher expense ratios than others. This can be due to things such as branding, marketing, or active management. But based on my points above: a good net expense ratio is generally below 0.10%. For an actively managed ETF, a good net expense ratio is generally below 0.6%.
Hopefully this was helpful and thanks as always for reading!
DISCLAIMER – THIS ARTICLE IS NOT FINANCIAL ADVICE. THIS ARTICLE DOES NOT CONSTITUTE A BUY, SELL, OR HOLD RECOMMENDATION ON ANY SECURITY MENTIONED HERE. THIS ARTICLE CONSTITUTES MY OPINION AND NOT A STATEMENT OF FACT. ALL INFORMATION REGARDING THE FINANCIAL SECURITIES MENTIONED IS ACCURATE AS OF JANUARY 19, 2024. DO YOUR OWN RESEARCH.