Index Fund Expense Ratios May Be Bottoming Out

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The Wall Street Journal recently speculated that expense ratios for the major index funds have reached the bottom. The call followed State Street’s reduction in the expense ratio for the SPDR Portfolio S&P 500 ETF (SPLG).

The expense ratio was cut by a single basis point from 0.03% to 0.02%. This translates to savings of $0.10 per year on every $1,000 invested. At this level, the move is more about bragging rights for State Street than it is about savings for investors.

SPDR Portfolio S&P 500 is the smallest of the four exchange-traded funds (ETFs) that directly track the S&P 500 index. Its assets under management (AUM) totaled $19.4 billion at the end of September. Its better-known brother, the SPDR S&P 500 ETF Trust (SPY), had AUM of $401 billion at the end of September. SPDR S&P 500’s expense ratio is comparatively pricey but still cheap at 0.09% ($0.90 on every $1,000 invested).

There are two other ETFs that directly track the S&P 500. The iShares Core S&P 500 ETF (IVV) and the Vanguard S&P 500 ETF (VOO) both have an expense ratio of 0.03% ($0.30 on every $1,000 invested).

On the mutual fund side, the cheapest S&P 500 tracking funds widely available to individual investors are the Fidelity 500 Index fund (FXAIX), the Schwab S&P 500 Index fund (SWPPX) and the Vanguard 500 Index Admiral fund (VFIAX). Fidelity 500 has an expense ratio of 0.02% but must be purchased through Fidelity. Schwab S&P 500 also has a 0.02% expense ratio but can be purchased by non-Schwab clients. Vanguard 500, which I own shares of, can also be purchased by non-Vanguard clients. Its expense ratio is 0.04%. Be sure to check if there are any transaction fees if you are purchasing the Schwab or Vanguard funds in a third-party account, such as a different broker.

There are other S&P 500 mutual funds available to individual investors, but their expense ratios are 0.16% and higher.

All seven of the aforementioned ETFs and mutual funds are very close in terms of returns and risk. I used our ETF Compare tool to create the table below. The ETF Compare tool is available to all AAII members. If you click on the link, you’ll be able to see the A+ Investor Grades for these seven funds and change which ETFs and/or mutual funds are being analyzed. (There is also a Mutual Fund Compare tool, though you can use either tool to do head-to-head comparisons of mutual funds and ETFs.)

There are subtle differences between the seven funds. SPDR Portfolio S&P 500 has a 10.0% five-year annualized return versus a 9.8% return for SPDR S&P 500, for instance. This is likely due to the differences in expense ratios. The turnover rates are also slightly different.

While we at AAII favor lower expense ratios, there is a point where it may not make sense to change to a similar fund with a lower expense ratio. Paying a transaction fee to buy or sell an index mutual fund is one such reason. The transaction fee for doing so could require a balance of $500,000 or more just to break even on the first year of one basis point in savings.

Taxes are another reason. If you’ve accumulated capital gains on the S&P 500 ETFs or mutual funds you currently own, the tax liability caused by selling those shares could be far larger in terms of absolute dollars than the savings you would realize by switching to a lower-cost alternative. The math is how much you’d owe in taxes versus how much you would save in lower expense ratios. This only applies to funds held in a taxable account.

A third reason is simply behavioral. It’s far more important to focus on having the right allocation for your goals and the ability to withstand volatility than it is to dwell on whether to switch from a fund with a 0.04% expense ratio to one with a 0.02% or 0.03% expense ratio. You also need to consider whether logging in to your brokerage or mutual fund account will prompt you to make other changes that you wouldn’t otherwise make because of how you feel about the market or certain investments right now. It’s easier to stay disciplined when temptation isn’t staring you right in the face.

All this said, if you are holding a large-cap mutual fund or ETF with a considerably higher expense ratio, it may make sense to take advantage of the cost savings. The expense ratios on these funds are now nearly as low as they can possibly go.