There are 3 costs involved with investing in Bond ETFs which are:
- The Spread
- The Expense Ratio
Here is an explanation of each.
When you buy and sell most Bond ETFs you are charged a commission, which is the same as the commission you pay for buying and selling stocks. This is in the range of $8 to $10 for both the buy and the sell with the major online brokers. If you are transacting through a full service broker, the fee can range from $50 up to $100 or more.
The spread is the difference between the price where you can buy an ETF and where you can sell it. For most actively traded ETFs this amounts to a few pennies at most, and is therefore not really a consideration. For less actively traded ETFs however, the spread can be quite large, so it is something to be aware of if you move away from the mainstream bond ETFs.
The Expense Ratio
Investors have to pay the company managing and administering the ETF for their services. This fee is calculated as a percentage of the assets invested in the ETF, over the course of a year. It is also a recurring fee, so it does not go away after the first year. According to Morningstar, the average bond ETF has an annual expense ratio of just 0.28%. However, half of bond ETFs had an annual expense ratio below 0.24%.
Why is the expense Ratio so Low?
One of the things that you will often hear about Bond ETFs is that they are highly cost efficient. There are three reasons for this:
- Smaller Number of Professional Staff: Most Bond ETFs are passively managed. Passively managed means the ETF tries to mirror the performance of either the market as a whole or an easily definable segment of the market. As a result, most ETFs do not require a large team of highly paid portfolio managers and researchers who are trying to be the market.
- Lower Marketing Costs: The expense ratio of bond mutual funds includes a 12b-1 fee which is for marketing and distribution. A large part of this fee goes to the brokerage firm for carrying the mutual fund. ETFs don’t have 12b-1 fees because access to them is not determined by a broker but available to anyone with a brokerage account.
- Lower Administrative Costs: Unlike a mutual fund company, an ETF manager does need to be heavily involved in the process and record keeping for changes in ownership. ETFs change ownership just like a stock.
Are Bond ETFs Less Expensive than Bond Mutual Funds?
That depends on your situation. To learn how to choose the least expensive option for your situation, read our article on Bond Mutual Fund Fees vs. Bond ETF Fees.