Why do mutual funds have higher expense ratios than ETFs?
Mutual funds are an older way of allowing a group of investors to own a share in a larger portfolio. Mutual funds tend to be actively managed, so they're trying to beat their benchmark, and may charge higher expenses than ETFs, including the possibility of sales commissions.
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.
Actively managed mutual funds typically have a higher expense ratio than passively managed funds, mainly because passively managed funds don't have managers and researchers who are actively choosing assets to buy and sell.
As an ETF's assets increase, its fixed costs likely represent a smaller percentage of its net assets, meaning its expense ratio often decreases. Actively managed ETFs tend to have higher expense ratios than passive, index-tracking funds.
An expense ratio reflects how much a mutual fund or an ETF (exchange-traded fund) pays for portfolio management, administration, marketing, and distribution, among other expenses.
How are ETFs and mutual funds different? How are they managed? 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.
This is because mutual funds are actively managed, involving research and decision-making by fund managers, while index funds passively track a specific market index, requiring less active management. As a result, mutual funds often have higher fees, including management fees and transaction costs.
A reasonable expense ratio for an actively managed portfolio is about 0.5% to 0.75%, while an expense ratio greater than 1.5% is typically considered high these days. For passive funds, the average expense ratio is about 0.12%.
Actively managed mutual funds command higher expense ratios, typically above 0.75% on average. Average expense ratios for passively managed equity index mutual funds and bond index funds are much smaller, typically under 0.10%.
Type of fund: ETFs are generally less expensive to operate compared to mutual funds, thus their expense ratios are typically lower. For example, equity ETFs average 0.16% expense ratios, whereas stock mutual funds average 0.47%. Underlying assets: Equity funds generally have higher expenses than bond funds.
What ETF has the highest expense ratio?
| Symbol | Name | Expense Ratio |
|---|---|---|
| BIZD | VanEck BDC Income ETF | 11.17% |
| VPC | Virtus Private Credit Strategy ETF | 9.72% |
| LBO | WHITEWOLF Publicly Listed Private Equity ETF | 6.82% |
| PBDC | Putnam BDC Income ETF | 6.79% |
| Symbol | Name | Expense Ratio |
|---|---|---|
| SPLG | SPDR Portfolio S&P 500 ETF | 0.02% |
| BBUS | JPMorgan BetaBuilders U.S. Equity ETF | 0.02% |
| BND | Vanguard Total Bond Market ETF | 0.03% |
| AGG | iShares Core U.S. Aggregate Bond ETF | 0.03% |
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.
Most ETFs have low expenses compared to actively managed mutual funds.
For most individual investors, ETFs represent an ideal type of asset with which to build a diversified portfolio. In addition, ETFs tend to have much lower expense ratios compared to actively managed funds, can be more tax-efficient, and offer the option to immediately reinvest dividends.
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.
For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.
Both are less risky than investing in individual stocks & bonds. ETFs and mutual funds both come with built-in diversification. One fund could include tens, hundreds, or even thousands of individual stocks or bonds in a single fund. So if 1 stock or bond is doing poorly, there's a chance that another is doing well.
| Fund | 2023 performance (%) | 5yr performance (%) |
|---|---|---|
| MS INVF US Insight | 52.26 | 34.65 |
| Sands Capital US Select Growth Fund | 51.3 | 76.97 |
| Natixis Loomis Sayles US Growth Equity | 49.56 | 111.67 |
| T. Rowe Price US Blue Chip Equity | 49.54 | 81.57 |
In fact, most index funds are a type of mutual fund. The main difference is that index funds are passively managed, while most other mutual funds are actively managed, which changes the way they work and the amount of fees you'll pay.
Which is better ETF or mutual fund?
Mutual funds and ETFs may hold stocks, bonds, or commodities. Both can track indexes, but ETFs tend to be more cost-effective and liquid since they trade on exchanges like shares of stock. Mutual funds can offer active management and greater regulatory oversight at a higher cost and only allow transactions once daily.
Since a regular plan mutual fund hires brokers, the brokerage fee is included in the expense ratio. However, if the investor chooses a direct plan mutual fund, they can avoid these brokerage fees, manage the fund themselves, and avoid a higher expense ratio.
Buy and sell: *Vanguard average ETF and mutual fund expense ratio: 0.08%. Industry average ETF and mutual fund expense ratio: 0.47%. All averages are asset-weighted.
“The best expense ratio is the lowest expense ratio,” Arnold says. It's important to compare a fund's expense ratio with similar offerings so you don't overpay for your fund's management services. In general, an expense ratio over 1% may be too high for the average investor.
Expense ratios matter because they reduce your net return on investment. For example, an expense ratio of 0.75% will reduce an average annual return of 7.00% to 6.25%. That might not make much of a difference in any single year.
