Here's How Super Low Index Fund Fees Could Help You Build Wealth

Management fees on exchange-traded funds (ETFs), mutual funds, and index funds have been getting steadily lower in recent years. That's great news for investors, particularly long-term ones. Over time, those management fees -- also known as expense ratios -- can really eat into your returns.

Most recently, per The Wall Street Journal, State Street Global Advisors cut the fee on its SPDR® Portfolio S&P 500® ETF. The index fund now has a super low expense ratio of 0.02%. To put that in context, if you invested $10,000, you'd pay $2 in annual fees. That's on top of trading fees and other costs, but it's still extremely low.

Time and rates of return are core components of wealth building

There are no guarantees when it comes to investing. There will be years when the stock market produces significant gains, and years when it declines. But, historically, consistently investing a percentage of your income is a proven way to build wealth over time.

How much wealth you can build really depends on the following three factors:

1. How much you invest
2. How long you invest it for
3. What rate of return you can get on your investments

There are ways to maximize the amount you invest by, say, reducing your spending so you have more available cash. Or using tax advantaged accounts and/or maximizing contributions to your work 401(k). In terms of time, the earlier you get started, the better. You want to give compound interest -- essentially earning interest on your interest -- lots of time to work its magic.

Your rate of return is harder to control. It depends on many things, including your tolerance for risk, the types of investments you choose, and the performance of the economy. In my case, I am mostly a passive investor and the majority of my brokerage account portfolio is in index funds and ETFs. As a result, reducing the amount I pay in annual fees can directly increase my rate of return.

Even a fraction of a percent matters

Expense ratios on passive funds, like index funds and ETFs, are usually much lower than on mutual funds, which require active management. According to the Investment Company Institute, the average expense ratio for ETFs in 2022 was 0.16%. The average expense ratio for mutual funds was 0.44%.

In addition to State Street's latest offer, several ETFs currently offer seriously low fees. For example, the expense ratios on our list of best low-cost index funds range from 0.03% to 0.06%. It's easy to look at those numbers and think, "Those fees are only 0.1% less than the average." But you'd be surprised at how much difference even a fraction of a percent could make.

Let's say you have $50,000 to invest and you put it all into an index fund that tracks the S&P 500. The S&P 500 has delivered average returns of over 10% over the past 30 years. We can use that 10% rate to illustrate how relatively small changes in the expense ratios get magnified over time. It is a big oversimplification. But it shows how that 0.1% difference could equate to tens of thousands more dollars in your old age.

Low fees aren't everything

The table above illustrates how much you can save with a low-fee index fund or ETF. But fees aren't the be all and end all. It's also important to look at the fund's performance -- particularly how closely it follows the index it tracks. Check to see if there are any minimum investment requirements. It's also worth avoiding ETFs with low trading volumes and declining asset levels. Check out our guide on choosing the right ETF for more information.