The first cost you face when investing in ETFs is the brokerage fee.
Every time you buy and sell units in an ETF, it is the same as if you were buying or selling shares in an individual company - you have to pay a brokerage fee.
ETFs also charge an annual management fee, which is generally included in the unit price (the current market price of units in the fund).
The management cost includes all relevant fees and costs associated with managing the ETF, including custodian fees, accounting fees, audit fees and index licence fees.
The annual cost is expressed as a percentage. For example, a 0.5% annual management cost would represent $50 on a $10,000 investment each year.
Management fees can vary significantly from one ETF to another so it’s important to check before investing. They can range from as low as 0.1% to as high as 1% or more.
Are there any other costs?
Another cost that you may incur when buying or selling an ETF is known as the ‘bid/ask’ spread.
This is the difference between the highest price that a buyer is willing to pay for units in an ETF, and the lowest price that a seller is willing to part with them for.
When you decide to buy or sell, the order will be placed as soon as possible at the best price available. However, depending on the bid/ask spread at the time, this may mean paying more than the ETF is worth.
Tax on distributions and capital gains applies to ETFs, just as it does with shares, and there may be different tax implications for investing in international ETFs.
For example, if you invest in an ETF that is operated in the US, you would be subject to US withholding tax. But this is generally reduced under the Australia/US Double Tax Agreement, based on a number of conditions.
ETFs vs managed funds
ETFs can compare favourably on the cost front to actively managed funds because they generally don’t buy and sell shares as often.
The more that investment funds buy and sell, the more they have to pay through commissions, which can affect a fund’s performance and eat into your returns.
However, as well as the potential for actively managed funds to deliver higher returns than ‘passive’ funds like ETFs, you can usually make regular contributions for no extra cost, whereas with an ETF you must pay a brokerage fee each time you invest.