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Tackle Today: Mind Your Expense Ratios

June 9, 2021

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The less they take, the more you keep

Traders,

If stacking cash in a diversified stock fund is part of your portfolio plan, then it’s worth knowing something about expense ratios.

Question: If the S&P 500 rises 10% this year, and you own an S&P 500 exchange-traded fund like SPY, do you make 10%?

Answer: No. You make 10% – fund expenses.

State Street (STT) is the trustee or provider of SPY. They are a for-profit company. They’re not providing you with a vehicle to invest in the S&P 500 for free, after all. The expense ratio, which is 0.095%, represents their cut.

Now, in the case of SPY, the expense is minuscule. In the example above, where the S&P 500 Index rises 10%, you would capture 9.905% (10% – 0.095%)

Obviously, the larger the fund expenses, the less you take home. Fortunately, there are multiple ETFs designed to track each Index or asset class. All else equal, you want to own the one with the lowest expense ratio.

What might justify me using an ETF with a higher expense ratio? I can think of two primary reasons. First, if I’m using it for a short-term trading vehicle, then the expense ratio is irrelevant. Second, if I’m trading options on it, then liquidity matters far more. For instance, VOO is the Vanguard equivalent of SPY, and it only carries an expense ratio of 0.03%, which is about a third of the cost of SPY. And yet, its listed options are garbage. It’s a poor substitute to SPY if you’re going to be engaging in covered calls or anything else of the sort.

#TeamTackle


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