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Are ETFs Really Cheaper Than Open-End Index funds?



While many people feel that ETFs are cheaper than Index MFs, a careful analysis will reveal it is not always the case.


Most people only consider expense ratio while deciding the cost of investing in Index fund and ETF, but several other costs can have significant impact. You should take into account all these costs before deciding which one is cheaper.

1.Expense ratio

This is the first expense people consider. ETF is clearly winner on this one. Most ETF have lower expense ratio as compared to similar index fund. This is mostly because ETF issuer does not sell to individual investors but sells to authorize participants. Authorized participant take the effort of selling to individual investors reducing workload for ETF issuer. ETF cost is lower here.

2.Brokerage/Commission

You should check the commission for buying index fund or ETF. If you are buying from your bank, there may not be any commission on index fund. But if you are buying from your brokerage firm, MF transaction cost can be high. There are also many commission free ETF as well as many no-transaction-fee MF. It is important to consider commission or brokerage, especially if you buy frequently or invest every month. In most cases, Index fund cost is lower here.

3.Bid-ask

Index fund do not carry any bid-ask spread, whereas ETF carry bid-ask spread just like stocks. This cost can be huge if ETF has low liquidity. Index fund cost is lower here.

4.Load

Index fund might carry front-end or back-end load. This is additional fees MF charges for sales related charges or commission. ETF has no load. So, ETF cost is lower here.

5.Tax

ETFs are usually more tax efficient than index fund due to different in kind creation/redemption process. In case of index fund, daily rebalancing due to net redemption need triggers tax event due to capital gain. Buying and selling is not required in case of ETF. ETF cost is lower here.

6.Dividend

Index fund reinvest the dividend immediately, whereas ETF accumulates dividend over a quarter and pays it at the end of the quarter. This distribution might force you to reinvest the dividend yourself incurring commission cost. Index fund cost is lower here.

So pick up the ETF and index fund you are considering for buying and check these costs before you decide which one is cheaper. The answer can go either way based on your situation.

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