ETFs for the Long Run: What They Are, How They Work, and Simple Strategies for Successful Long-Term Investing

CHAPTER 6

The Better Mousetrap

How Can ETFs Charge So Little?

 

Whenever you read or hear about ETFs, people recite their benefits over mutual funds as if they were reciting a mantra: low costs, tax efficiency, transparency, and flexibility. But few people understand how this comes about. As Chapter 5 explained, your fund’s returns can’t be known ahead of time, but its costs can. And higher costs mean less money in your pocket.

From the investor’s point of view, mutual funds are inefficient. Funds charge their shareholders for everything that goes on inside the fund, such as transaction fees, distribution charges, and transfer-agent costs. In addition, they pass along their capital gains tax bill on an annual basis. These costs decrease the shareholder’s return on his investment. On top of that, many funds charge a sales load for allowing you the pleasure of investing with them.

Mutual funds charge a combination of transparent and not-so-transparent costs that add up. It’s simply the way they are structured. Most, but not all, of these costs are necessary to the process. Most could be a little cheaper; some could be a lot cheaper. But it’s nearly impossible to get rid of them altogether. ETFs have transparent and hidden fees as well—there are simply fewer of them, and they cost less.

This chapter will pull back the curtain and expose the many costs inherent in the mutual fund structure. It will unscrew the nuts and bolts of mutual funds and ETFs to examine their many moving pieces, ...