How Do Fees Impact Your ETF Investment Returns?

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There is an opposite force at work when it comes to investment fees. The late Vanguard founder and chairman John Bogle famously called it "the tyranny of compounding costs."

The mathematics works much like compounding returns, except in reverse. Every dollar removed from your portfolio to pay investment expenses is a dollar that can no longer remain invested and compound on your behalf.

That means the long-term cost of a fee extends beyond the amount initially deducted. You also lose whatever investment returns that money might have subsequently earned.

Over a sufficiently long holding period, even seemingly small differences in annual fees can add up.

Fortunately, the exchange-traded fund (ETF) industry has experienced a sustained trend toward fee compression.

Competition among major asset managers has pushed the expense ratios of many broad-market index ETFs toward just a few basis points, making portfolios considerably cheaper to create.

Fees are one of the few variables you can know in advance and control.

Morningstar research has repeatedly found that costs are among the more reliable predictors of future fund performance, with lower-cost funds generally having better odds of outperforming more expensive peers.

If you're new to ETFs and are not sure how to read or interpret their fees, this guide is for you.

We'll explain the different ways Wall Street can make money from the ETFs you own, show how seemingly small costs can compound over time and highlight several notable low-cost (and even zero-fee) ETFs.

What fees do ETFs pay?

ETF providers are required to prominently disclose the costs investors pay to own their funds. The most important number to understand is the expense ratio, which calculates an ETF's annual operating expenses as a percentage of its assets.

You do not pay the expense ratio upfront when purchasing an ETF, nor will you receive a separate bill from the fund manager. Instead, expenses accrue daily and are deducted from the ETF's net asset value (NAV) behind the scenes.

Because those costs are already reflected in the funds NAV, investors can sometimes overlook how much they're actually paying.

Interpreting an expense ratio is straightforward. Divide the percentage by 100 and multiply it by the amount you have invested to estimate the annual cost.

For example, an ETF with a 0.10% expense ratio would cost approximately $10 annually for every $10,000 invested, assuming the value of your investment remained constant throughout the year.

The expense ratio itself can incorporate several different costs. A major component is the management fee, which compensates the ETF provider for managing and operating the portfolio.

Depending on the fund, operating expenses can also cover index licensing, administration, accounting, record keeping, custody, legal services, marketing and distribution required to keep the ETF running.

Another cost investors may encounter is acquired fund fees and expenses. These can arise when an ETF uses a "fund-of-funds" structure, meaning it obtains some or all of its exposure by investing in other funds.

Expenses incurred by those underlying funds can effectively pass through to shareholders and contribute to the overall cost of the strategy.

Expense ratios are also not necessarily static. Competitive pressure has driven fees downward across much of the ETF industry, while providers occasionally introduce temporary fee waivers to make newly launched funds more attractive.

A prominent example occurred around the January 2024 launch of U.S. spot bitcoin ETFs, when several issuers temporarily waived some or all of their management fees, often subject to a time limit or asset threshold, as they competed for early investor inflows.

All else being equal, passively managed index ETFs tend to be cheaper than active ETFs.

A fund that simply attempts to replicate a well-established benchmark such as the S&P 500 can generally operate more cheaply than one employing a team of portfolio managers and analysts to research securities and decide what to buy and sell.

ETFs targeting a particular sector, industry, country or other narrow segment of the market may charge more than broad-market index funds. More complex strategies can charge considerably more.

Alternative ETFs employing derivatives such as swaps, options and futures, short selling, leverage, or other hedge fund-like techniques can see expense ratios exceeding 0.75%.

Still, there is no single expense ratio figure that qualifies as cheap or pricey across the entire ETF market.

The more useful approach is to compare an ETF's expense ratio with another offering similar exposure. If two ETFs are doing the same thing, however, the lower-cost option begins with a measurable advantage.

A real-life example of ETF fees in practice

ETF fees are best compared on an apples-to-apples basis.

Fortunately, there are ETFs that are almost identical under the hood. They track the same benchmark, own substantially the same securities in the same proportions and pursue the same investment objective.

In these cases, a difference in performance attributable to higher or lower fees becomes much easier to isolate.

A good example is the S&P 500 Value Index. Two longstanding ETFs track this same benchmark: the iShares S&P 500 Value ETF (IVE) and the State Street SPDR Portfolio S&P 500 Value ETF (SPYV).

IVE currently charges a 0.18% expense ratio, while SPYV charges just 0.04%, making the latter less than a quarter as expensive. On a $10,000 investment, that translates into $18 vs $4 in annual fund expenses, assuming the investment's value remained constant.

From October 2, 2000, through August 27, 2026, a period just shy of 26 years, IVE generated a 7.5% annualized total return before taxes, equivalent to a cumulative return of approximately 556.50%.

SPYV returned 7.9% annualized before taxes over the same period. That seemingly modest annual advantage compounded into a cumulative return of 618.3%.

For an investor starting with $10,000, the difference becomes easier to appreciate in dollar terms.

By August 27, the IVE investment would have grown to approximately $65,649.95 before taxes, while the same amount invested in SPYV would have reached approximately $71,831.16.

That's a difference of more than $6,100 from two ETFs designed to provide essentially the same market exposure.

There can be other reasons two ETFs tracking the same index produce different returns.

Portfolio managers may differ in how efficiently they replicate the benchmark, execute trades, manage cash flows, handle index reconstitutions or generate incremental revenue through practices such as securities lending.

"Tracking difference" can therefore never be attributed entirely to the headline expense ratio.

In this comparison, however, the clearest structural difference is cost. IVE vs SPYV is Bogle's "tyranny of compounding costs" in practice.

A few basis points may look inconsequential when viewed over a single year. But when look-alike ETFs provide essentially the same exposure, paying more creates a hurdle that the more expensive fund must overcome year after year.

How to find the lowest-fee ETFs

A variety of online ETF screeners allow investors to filter thousands of funds by expense ratio and sort the results from lowest to highest. That can quickly identify the cheapest products within a particular ETF type.

Using data from ETF Central's ETF screener, we took the liberty of doing some of that work for you.

Below, we identified the lowest-cost candidates across four major categories: equities, fixed-income commodities and cryptocurrencies.

Each demonstrates how inexpensive ETF investing has become, although the risks, yield, expected returns and appropriate uses of these funds differ considerably.

Equities: BNY Mellon U.S. Large Cap Core Equity ETF

• Expense ratio: 0.00%
• Assets under management: $5.8 billion
• 30-day median bid-ask spread: 0.02%
• 30-day SEC yield: 1.1%
• Five-year annualized total return: 12.9%

The BNY Mellon U.S. Large Cap Core Equity ETF (BKLC) is an example of a genuine zero-fee ETF, rather than a fund temporarily advertising a 0% expense ratio through a promotional fee waiver.

BKLC is currently the cheapest way to obtain diversified exposure to U.S. large-cap stocks with an ETF.

Part of what makes that possible is the choice of benchmark. Rather than licensing a household-name index such as the S&P 500, BKLC tracks the Solactive GBS United States 500 Index, providing exposure to roughly 500 of the largest U.S. companies through a lower-cost indexing arrangement.

The fund can also generate revenue through securities lending. This involves temporarily lending some of the stocks it owns to other market participants, including short sellers, in exchange for collateral and lending fees. The resulting income can help offset some of the costs involved in operating the portfolio.

Despite not tracking the S&P 500 itself, BKLC looks remarkably similar in practice. Its largest holdings include many of the same U.S. mega-cap companies, while its sector allocations broadly resemble those of conventional S&P 500 ETFs. Investors therefore receive much of the same economic exposure without an expense ratio steadily subtracting from returns.

There is one important diversification limitation. BKLC invests in U.S. equities, so investors using it as a core stock holding will still be missing exposure to international developed and emerging markets. Those wanting a globally diversified equity portfolio would need to complement it with an international ETF.

Learn more about BKLC at the BNY Investments provider site.

Fixed income: BNY Mellon Core Bond ETF

• Expense ratio: 0.00%
• Assets under management: $2.3 billion
• 30-day median bid-ask spread: 0.02%
• 30-day SEC yield: 4.8%
• Five-year annualized total return: -0.4%

For investors with a lower risk tolerance or shorter time horizon, one of the simplest ways to reduce portfolio risk is to allocate a portion of their assets to bonds.

Bonds can generate regular interest income, while high-quality bonds may also provide stability or potential price appreciation during periods of stock-market turmoil, particularly when falling interest rates accompany an economic slowdown.

The cheapest broad bond ETF on our list is the BNY Mellon Core Bond ETF (BKAG). The ETF charges a 0% expense ratio, giving investors diversified fixed-income exposure without an ongoing management fee.

BKAG tracks the Bloomberg U.S. Aggregate Bond Index, one of the broadest benchmarks for the U.S. investment-grade bond market.

Its portfolio contains more than 4,000 securities spanning Treasury bonds and other government-related debt, mortgage-backed securities and investment-grade corporate bonds. It also spreads its exposure across short-, intermediate- and longer-term maturities rather than concentrating on one particular segment of the yield curve.

The income potential is considerably higher than what investors currently receive from broad U.S. stock ETFs. BKAG offers a 4.8% 30-day SEC yield, compared with yields closer to 1% for many large-cap equity ETFs.

Investors should not necessarily expect substantial capital appreciation, however.

Bonds may be less volatile than stocks, but they can still lose money. Bond prices generally move inversely to interest rates, meaning existing bonds can decline in value when market rates rise.

The sharp increase in interest rates earlier this decade illustrates that risk. BKAG's five-year annualized total return is currently -0.4%, despite the income generated by its portfolio.

Learn more about BKAG at the BNY Investments provider site.

Commodities: iShares Gold Trust Micro

• Expense ratio: 0.09%
• Assets under management: $8.1 billion
• 30-day median bid-ask spread: 0.02%
• 30-day SEC yield: 0.0%
• Five-year annualized total return: 17.9%

Most investors can accomplish the bulk of their long-term retirement goals with a diversified, low-cost portfolio of stocks and bonds. In some cases, however, adding modest commodity exposure can provide another source of diversification because their returns are driven by different factors.

Precious metals are among the most popular choices. Gold has historically attracted investor demand during periods of elevated inflation and economic or geopolitical uncertainty. In 2022, for example, when rising interest rates pressured both stocks and bonds, gold offered a relative safe haven.

Gold is also particularly well suited to the ETF structure because the commodity can be physically held rather than accessed through futures contracts, which are derivatives that provide exposure to a commodity's future price and must periodically be rolled as they approach expiration.

These so-called spot gold ETFs instead hold physical bullion on behalf of investors.

Among these products, the iShares Gold Trust Micro (IAUM) is currently the lowest-cost option, charging an expense ratio of just 0.09%.

IAUM is designed to reflect the performance of the LBMA Gold Price, less its expenses, by holding physical gold bullion. It currently holds about 1.8 million ounces of gold in trust with a custodian, with the bullion holdings subject to verification and audit procedures.

Unlike stocks and bonds, however, gold produces no underlying cash flow. There are no corporate earnings, dividends or bond coupons being generated by the bullion sitting in a vault.

That explains IAUM's 0.0% 30-day SEC yield, and it means investors depend primarily on appreciation in the price of gold.

Learn more about IAUM at the iShares provider site.

Cryptocurrency: Morgan Stanley Bitcoin Trust

• Expense ratio: 0.14%
• Assets under management: $615.7 million
• 30-day median bid-ask spread: 0.05%
• 30-day SEC yield: 0.0%
• Five-year annualized total return: N/A

Before spot cryptocurrency and bitcoin ETFs became available in the U.S., investors looking to own bitcoin generally had to purchase it through a cryptocurrency exchange such as Coinbase.

Packaging Bitcoin inside an ETF made the process considerably more familiar. Investors can buy and sell shares through a conventional brokerage account during market hours, with transparent pricing and daily liquidity similar to stocks.

The trade-off is that investors pay an ongoing fee for custody, administration and operation of the product. But competition has pushed those fees surprisingly low for an asset class that was considered relatively exotic only a few years ago.

One of the newest entrants is the Morgan Stanley Bitcoin Trust (MSBT), which charges a 0.14% expense ratio, undercutting many competitors.

Like IAUM's approach to gold, MSBT is a spot product. Rather than using Bitcoin futures contracts to approximate the cryptocurrency's returns, the trust holds Bitcoin with a custodian.

Its NAV is therefore designed to move alongside the market value of its underlying Bitcoin holdings, less fees and expenses.

Bitcoin also shares an important characteristic with physical gold: It does not inherently produce income. There are no corporate earnings, dividends or bond coupons supporting the asset.

That's why MSBT has a 0.0% 30-day SEC yield. This ETF depends on appreciation in bitcoin's price to generate returns.

MSBT is too new to have a five-year performance record, but investors should already be familiar with bitcoin's potential for volatile price swings.

If you decide cryptocurrency belongs in your portfolio, consider erring on the side of caution and starting with a small allocation.

Learn more about MSBT at the Morgan Stanley provider site.

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