Exchange-Traded Funds (ETFs) have become increasingly popular investment options in recent years. They offer a convenient and cost-effective way for investors to gain exposure to a wide range of asset classes and sectors, including stocks, bonds, and commodities. ETFs are traded on stock exchanges, just like individual stocks, and can be bought and sold throughout the trading day.
While ETFs have many benefits, they also come with costs, commissions, and fees that investors need to be aware of. These expenses can eat into an investor’s returns and can vary widely between different ETFs. It’s important to understand the different types of costs associated with ETFs and how they can impact an investor’s bottom line.
In this blog post, we’ll take a closer look at the costs, commissions, and fees associated with ETFs. We’ll explain the various types of expenses that investors may incur when investing in ETFs, such as expense ratio, entry and exit load, and taxes. We’ll also provide tips on how investors can minimize these costs and maximize their returns. By the end of this post, you’ll have a better understanding of the costs associated with ETFs and how to choose the right ETFs for your investment needs.
Types of costs
Expense ratios are the major costs involved in ETFs or Mutual Funds. The net expense ratio includes waivers, reimbursements, and trading costs, whereas the Gross expense ratio is equal to the percentage of total mutual fund assets used to run the fund.
The expense ratio is a measure of the annual fund operating expenses of an investment fund. It is expressed as a percentage of the fund’s assets under management (AUM). The fund’s operating expenses include spending on administration, management, and advertising.
The expense ratios for ETFs range from 0.1% to 0.7% per annum which includes all the fees the fund house is charging. Within Mutual Funds, a direct mutual fund incurs an expense ratio of about 1% per annum. Regular mutual funds, which are purchased through brokers and agents, attract an expense ratio of around 1.5-2% per annum.
Entry load is the commission paid by the investor to the fund manager for participating in that fund. SEBI doesn’t allow fund houses to charge entry load from investors.
Exit load is charged by funds when you withdraw your money from the fund. It is the fee charged by fund houses to discourage investors from early withdrawals.
Since ETFs trade like shares on a stock exchange, there is no entry or exit load involved in dealing with ETFs. Investors can buy and sell the shares of the ETF just like other stocks.
Some Mutual Funds, on the other hand, involve an exit load. Because of no exit or entry load, ETFs enjoy good liquidity on the stock exchanges. SEBI has permitted an exit load of up to 7%, for Mutual Funds, but most mutual funds charge 1% of the AUM if you withdraw within 1 year of investing. There is no exit load if you sell off the units 1 year after you purchased them.
Brokerage, STT, and Other Charges
Your broker also charges certain fees for its services, called brokerage charges. The average brokerage charge on purchasing ETFs is 0.01% of the turnover value.
There are certain charges that the SEBI levies on the purchase of stocks from an exchange. Since ETFs also trade like stocks and are listed on the exchange, ETFs attract such charges from SEBI. Apart from that, STT stands for Securities Transactions Tax and stands at 0.01% of your turnover value.
Demat Transaction charges are the fee charged by your Depository institution to keep your shares in a demat form. DTC charges range from Rs. 15-40 depending on your broker and his Depository Participant.
18% GST is also charged by the Government of India on brokerage + transaction charges. These are levied on both, ETFs and Mutual Funds but form a very small part of the overall fee.
The below table shows the major differences between ETFs and Mutual Funds:
Below is a table that shows what happens to your investment after a year of investing in ETFs and Mutual Funds for up to 1 year. We assume that both the funds gave a 0% return, for simplicity of calculation.
Comparison between ETF and Mutual fund costs
In conclusion, investing in ETFs and mutual funds can be an excellent way to diversify your portfolio and achieve your financial goals. However, it’s essential to understand the costs, commissions, and fees associated with these securities to maximize your returns and minimize your expenses.
After analyzing the costs, commissions, and fees associated with ETFs and mutual funds, it’s clear that ETFs have an edge over mutual funds in terms of lower costs. This is mainly due to the passive management style of ETFs, resulting in lower expense ratios.
However, it’s important to note that both ETFs and mutual funds have their advantages and disadvantages, and investors should choose the right instrument based on their financial goals and risk appetite.
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