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.
In Jan. 2024, the SEC approved eleven spot bitcoin ETFs that will trade on the NYSE Arca, Cboe BZX, and Nasdaq exchanges. On May 23, 2024, the SEC approved applications from the same exchanges to list spot ether ETFs, which began trading in July 2024.
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
Both ETFs and mutual funds are popular investment choices. ETF investments usually have lower fees than mutual funds, however mutual fund investors get professional fund management services for their fees. Whether you decide to invest in ETFs or mutual funds may depend on the type of investor you are.
Are mutual fund fees the same as ETF fees? ›
Both ETFs and mutual funds are popular investment choices. ETF investments usually have lower fees than mutual funds, however mutual fund investors get professional fund management services for their fees. Whether you decide to invest in ETFs or mutual funds may depend on the type of investor you are.
How to compare ETFs and mutual funds? ›
While they can be actively or passively managed by fund managers, most ETFs are passive investments pegged to the performance of a particular index. Mutual funds come in both active and indexed varieties, but most are actively managed. Active mutual funds are managed by fund managers.
How do you compare mutual fund expense ratios? ›
This is represented by the expense ratio formula, which is calculated by dividing total expenses by the total assets of the funds. The higher the asset base, the smaller the ratio, and vice versa, assuming total expenses stay constant.
How are ETFs taxed compared to mutual funds? ›
Although similar to mutual funds, equity ETFs are generally more tax-efficient because they tend not to distribute a lot of capital gains.
How to calculate ETF fees? ›
ETFs typically have an expense ratio of 0.05%. An investor can determine the expense ratio by dividing the annual expenses of the investment by the fund's total value, though the expense ratio is also typically found on the fund's website.
How much should ETF fees be? ›
Investment fee
It's taken as a percentage of an investor's stake in an ETF. An investor with a $10,000 stake in an ETF charging 1% would pay $100 in fees paid per year. However, you won't see this charge on your brokerage account. It is automatically taken from your ETF as part of the unit price.
What are 2 key differences between ETFs and mutual funds? ›
With a mutual fund, you buy and sell based on dollars, not market price or shares. And you can specify any dollar amount you want—down to the penny or as a nice round figure, like $3,000. With an ETF, you buy and sell based on market price—and you can only trade full shares.
Why are ETFs so much cheaper than mutual funds? ›
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.
What is the downside of ETF vs mutual fund? ›
ETFs often generate fewer capital gains for investors than mutual funds. This is partly because so many of them are passively managed and don't change their holdings that often.
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.
How to calculate mutual fund fees? ›
The most common method for determining a mutual fund's price is as a percentage of its net asset value (NAV). NAV is the value of the fund's assets, less its liabilities. The NAV is updated once a day, usually after the markets close. The expense ratio is calculated as a percentage of the NAV.
Do ETFs or mutual funds have higher expense ratios? ›
ETF Expense Ratios Are Usually Lower Than Mutual Funds
The average expense ratio for index ETFs is typically lower than that of index mutual funds, historically 0.52% for ETFs versus 0.85% for mutual funds. Importantly, the higher costs of mutual funds can add up and impact portfolio returns over the long run.
Do ETFs pay more than mutual funds? ›
As passively managed portfolios, ETFs (and index funds) tend to realize fewer capital gains than actively managed mutual funds.
Why choose a mutual fund over an ETF? ›
Unlike ETFs, mutual funds can offer more specific strategies as well as blends of strategies. Mutual funds offer the same type of indexed investing options as ETFs but also an array of actively and passively managed options that can be fine-tuned to cater to an investor's needs.
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.
Do ETFs usually have higher management fees than active 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.
What is the difference between ETF and index fund fees? ›
The Investment Company Institute® found index mutual funds' expense ratios were 0.05% per year on average in 2023, a rate that's been declining for years. Index equity ETFs' asset-weighted average expense ratio for 2023 was higher, at 0.15%. But there are multiple S&P 500® ETFs that charge 0.03% per year.
Are ETF management fees the same as expense ratio? ›
Management fees include expenses ranging from manager salaries to custodial services and marketing costs. These fees reduce the value of an ETF investment. They're a subset of the total management expense ratio (MER). MERs are generally lower for passive funds than for active ones.
What is the difference between ETF and mutual fund? ›
ETFs are passively managed, which means the fund mirrors a particular index, making them less risky and transparent. Mutual funds are actively managed, which means fund managers invest in securities based on their analysis and market outlook. ETFs allow investors to start with smaller amounts.
