Exchange-traded funds (ETFs) have been one of the fastest-growing investment products in recent years. Their trading flexibility and low expenses have attracted millions of investors to their doors. But as more and more of these funds are being rushed to market, expenses on some ETFs have begun to creep up. In fact, some ETFs now charge more than many actively managed mutual funds. Why are some of these funds so expensive?
Forecast: rising expenses
According to Morningstar data, 33 ETFs currently clock in with an expense ratio of 0.95% or higher, summarized below:
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The 33 Most Expensive Exchange-Traded Funds |
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1 HealthShares European Specialty Health Fund |
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15 Claymore Specialty Funds |
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15 ProShares Ultra Index Funds (leveraged long) |
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2 ProShares UltraShort Index Funds (leveraged short) |
All of these funds serve a much different purpose than most inexpensive, broad-market exchange-traded funds. The funds in the chart allow investors to invest in a more obscure, narrow segments of the market (HealthShares and Claymore), or leverage their bets to twice what the market either gains (ProShares Ultra) or loses (ProShares Ultra Short). In such a case, the added expenses may seem reasonable.
After all, one should expect to pay more for funds that allow investors to engage in these otherwise operationally difficult strategies. While paying up for an ETF that holds shares of commonly held stocks like Microsoft
But odds are any investors who are interested in selling the market short or leveraging to twice the market's return are not going to be long-term holders of these types of ETFs. Most people who buy these more expensive ETFs will likely be making frequent trades into and out of these funds, racking up further trading costs and commissions. These funds are made for market timers and not long-term investors; that should make it pretty clear whether or not these funds are right for you.
Proper care and feeding of ETFs
Exchange-traded funds can be an excellent investment vehicle for investors, but only if they are used properly. Just because these funds can be traded throughout the day doesn't mean they should be. ETFs can provide an inexpensive way to get passive exposure to the market, and that is how they are best used by investors. Unfortunately, too many folks take advantage of ETFs' trading flexibility to make frequent trades in an attempt to make a quick short-term profit. Not only are most investors really bad at successfully timing the market, but they also oftentimes pay more for those exotic funds that allow them to do so.
In a perfect world, people who buy ETFs do so because they are satisfied with the market rate of return -- there is no active management within ETFs. At least not yet. And if you are seeking the market rate of return, costs should be of primary importance to you. You want the fund that can get the job done for the smallest expense. Anything above that, and your ETF will start to lag the market, weighed down by unnecessary costs.
So if you are thinking of buying exchange-traded funds, stick to broad-market, well-diversified funds with low expenses. A fund like Vanguard Total Stock Market ETF (VTI), for instance, combines big companies like Google
Although some of the new ETFs may seem alluring, they are too expensive to warrant a place in your portfolio. There is no reason why anyone should overpay to own an exchange-traded fund. Leave the pricey funds to someone else -- your portfolio will thank you.
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