*This blog post is my personal opinion only and may contain affiliate/referral links.
.75% of $10,000 is $75. If you are an investor, let this sink in because you could be paying this expense ratio every year.
What expense ratio means to an investor are fees that will accumulate on the life of their investments. It’s worth noting that some investors dive into an ETF or mutual fund without taking into consideration the expense ratios that will eat into their capital gains in the future.
According to Wikipedia’s definition, expense ratio is the “total percentage of fund assets used for administrative, management, advertising, and all other expenses”. In plain language, it means investors need to pay the fund managers and their team to run the show and make sure everything is in compliance with SEC or Securities and Exchange Commission. The underlying goal, of course, is to make the right fund picks so your money will grow on their capable hands. .
For this blog post, i will touch on two ETFs with two different approach; first one is VTI (Vanguard Total Stock Market Index Fund ETF) and other is ARKK (ARK Innovation ETF). Both ETFs are giants on their own right but have totally different investing goal.
The lower expense ratio of the two, VTI is a Vanguard ETF since 2001that seeks to track the US Total Market Index. The fund holdings range from large cap to small cap and is diversified with value and growth companies. It has one of the lowest expense ratio out there, which is 0.03%; therefore for a $10,000 investment, the investor is charged $3/year. Let’s say VTI has 10% return for that year, the investor is left with $10,096.97. To put that on a more detail perspective, here is the actual 10 year performance of VTI.
Back to our .75% example, this is actually the expense ratio of ARKK, the brainchild of stock picker extraordinaire Cathie Wood. This actively managely ETF looks for “disruptive innovation” for long term growth of capital. Disruptive can be on the field of genomics, fintech, industrial or next generation internet. As of this writing, the price of ARKK is $122, up significantly from $37 a year ago, and if you happen to invest and hold it for the whole of 2020, you can definitely say what a banner year that was.
While the two ETFs has a big disparity on expense ratios, it is important to note that an investor has to look on his or her thesis in determining the right ETF for his portfolio. Having an investment like an index tracker ETF is passive enough to eliminate the worry of overpaying for fees, but that doesn’t mean it will have a lackluster performance (as we have seen on 10 year performance table above); on the other hand, an actively managed ETF like ARRK has not only a higher ceiling of reward but also considerable risk taking for a diversifying investor.
Whatever niche an investor picks, he or she has to take into account the expense ratio of the ETF. Normally, passively managed ETFs have lower ER and actively managed have higher ER, but that is not to say one is good than the other. When choosing a low or high ER ETF, he or she has to see the big picture i.e. his or her time horizon and risk tolerance. These two factors when integrated with the investment thesis will give the investor a steady anchor on his ETF of choice.
*Full disclosure, I own VTI on Vanguard and also on Betterment.