ETF Expense Ratios and Fees
Understand expense ratios, trading costs, bid–ask spreads, and tracking difference so you can keep more of your ETF returns over the long term.
Why Small Fees Matter Over Decades
ETF investing is often marketed as low-cost, but costs still exist—and they compound in reverse. A difference of even half a percentage point in annual fees can lead to a surprisingly large gap in ending wealth over 20 or 30 years. Understanding expense ratios, trading costs, and hidden frictions helps you keep more of your returns.
Fees are not the only factor in choosing an ETF, but they are one of the few you can control directly. Once you settle on a diversified asset mix, keeping costs modest is a straightforward way to tilt the odds in your favour.
Expense Ratios (MER): The Ongoing Cost
The management expense ratio (MER) or expense ratio is the annual fee charged by a fund or ETF to cover management, administration, and operating costs. It is expressed as a percentage of assets. For example, an ETF with a 0.20% expense ratio charges roughly $20 per year for every $10,000 invested. This cost is embedded in the fund’s returns rather than billed as a separate line item.
Broad market index ETFs often have very low expense ratios, while specialized, niche, or actively managed funds tend to be more expensive. When two funds offer similar exposure, the lower-cost option usually leaves you better off over the long term.
Trading Costs: Commissions and Bid–Ask Spreads
In addition to ongoing fund fees, there are costs associated with buying and selling ETFs:
- Commissions: some brokers charge a flat fee per trade; others offer commission-free trading on certain ETFs.
- Bid–ask spread: the difference between the price at which you can sell (bid) and the price at which you can buy (ask). The spread is a real cost each time you trade.
For long-term investors who trade infrequently, commissions and spreads may be a minor cost compared with the MER, but they still matter. Narrow spreads and sensible trading practices help keep these frictions small. Our ETF liquidity guide explains this in more detail.
Illustration: Impact of Different Expense Ratios
Consider two hypothetical portfolios invested for 30 years with the same contributions and gross returns, but different expense ratios:
| Scenario (Illustrative) | Expense Ratio | Effect on Ending Value |
|---|---|---|
| Low-cost index ETF | 0.20% per year | Higher ending balance |
| Higher-fee fund | 1.20% per year | Significantly lower ending balance |
Even though a one percent difference feels small, it is applied every year to a growing base. The difference compounds, leading to a gap that can reach tens of thousands of dollars or more depending on contributions and returns.
Comparing ETFs Within the Same Category
Fees should be compared among funds that provide similar exposure. A global equity ETF, a sector-specific ETF, and a bond ETF serve different roles, so their expense ratios are not directly comparable. When you narrow the universe to a specific category—such as large-cap domestic equities—small differences in fees become meaningful.
When comparing ETFs in the same category, consider:
- The underlying index and methodology.
- The expense ratio.
- Fund size and trading volume.
- Historical tracking of the index.
Expense ratio is not the only metric, but in otherwise similar funds, the lower-cost choice usually has the edge.
Tracking Difference and Tracking Error
Tracking difference is the gap between an ETF’s return and the return of its benchmark index over time. Ideally, a low-cost index ETF will lag its benchmark by approximately the amount of its expense ratio plus any implementation frictions. Tracking error measures how much that difference varies from period to period.
Large, persistent tracking differences that exceed the stated fee can signal additional costs, such as inefficient replication, higher turnover, or other frictions. For long-term investors, an ETF with a low fee and tight tracking difference is generally desirable.
Liquidity, Spreads, and Trade Execution
ETF liquidity is often misunderstood. While daily trading volume matters, the real source of liquidity is the underlying securities in the ETF’s portfolio. Highly diversified, broad-market ETFs that hold liquid stocks or bonds often have narrower bid–ask spreads than niche products with less liquid holdings.
Good trading habits include:
- Avoiding market orders at the open or close when spreads may be wider.
- Using limit orders to control the price you pay or receive.
- Being mindful of days with unusually high volatility or breaking news.
These practices help you minimize trading costs so that more of your money goes toward the investments themselves rather than frictions.
Putting Fees in the Context of Your Plan
While it is important to respect the impact of fees, cost is only one part of a sound investment plan. A low-fee strategy that you cannot follow is not better than a slightly more expensive one that fits your preferences and risk tolerance. The goal is to find cost-efficient tools that support your broader asset allocation and behaviour.
Start by designing your asset mix, then choose ETFs that fit that mix with reasonable fees, solid diversification, and enough liquidity for your needs. Revisit your holdings periodically to check whether lower-cost alternatives have appeared in the same category.
Quick Checklist for Evaluating ETF Costs
When you evaluate an ETF, run through this quick list:
- Is the fund’s exposure aligned with my asset allocation plan?
- What is the expense ratio, and how does it compare with similar funds?
- Are bid–ask spreads typically narrow during normal trading hours?
- How closely has the ETF tracked its benchmark over time?
- Are there any additional account-level fees or commissions from my broker?
Answering these questions will not guarantee a specific outcome, but it will keep costs and implementation risks under control.
FAQs
- Is the lowest-fee ETF always the best choice?
- Not always. Fees matter, but so do index construction, diversification, liquidity, and tracking. Among similar funds, fee level is a strong tie-breaker.
- How often should I review fees in my portfolio?
- Review annually or when you make significant changes to your asset allocation. New lower-cost options may appear over time.
- Do trading costs matter if I rarely trade?
- If you trade infrequently, commissions and spreads are usually a smaller part of your total cost than ongoing expense ratios. Still, using limit orders and avoiding poor trading times can keep these costs modest.