The #1 Thing You Need To Know Before You Buy An ETF

Last week in The Juice, we discussed international dividend stocks as we segued into a couple of international ETF ideas that blend growth and income. 

Between the two we featured, we ended up leaning toward a Vanguard ETF, largely because of the fund’s ultra-low expense ratio of 0.07%. For more on the comparison we made, see the link in today’s Freshly Squeezed section.

So, to cut to the chase, we think that (in most cases) you would be crazy to buy an ETF with anything other than an “ultra-low” expense ratio. The Juice provides our rationale on this in a second alongside our favorite international ETF pick. 

But first, a quick refresher on ETF expense ratios—

Using the most straightforward, all else equal definition, an expense ratio covers the work fund managers do to run an ETF. Generally, the more work — and the more moving parts — the higher the expense ratio. 

Therefore, basic, broad market-tracking ETFs, such as SPDR S&P 500 ETF (SPY) and Invesco QQQ ETF (QQQ), tend to have lower — and, often, among the lowest — expense ratios. 

SPY’s expense ratio is 0.09%. QQQ’s is 0.20%. VOO, which is Vanguard’s S&P 500 Index tracking ETF (VOO), comes in even lower at 0.03%. 

Vanguard is the pioneer in the low-cost — and this is key — broad market index tracking ETF space.  

For an extreme comparison, leveraged ETFs (which are not made for long-term investment) have super high expense ratios. For example, TQQQ’s expense ratio is 0.88%. SQQQ’s expense ratio is 0.95%. Both high. Because, here again, it takes more work to manage these ETFs. For more on the funds mentioned here, see What Are Alternative ETFs in Freshly Squeezed.

In dollars and cents, this means that if you have $100,000 invested in SPY, you’ll pay $90 in year one on that balance. But it’s not just a $90 annual fee. It’s based on your balance. So, as your investment grows, you pay more each year. A 0.09% expense ratio on a $120,000 balance equals $108.

In a fund with a 0.95% expense ratio, you’re paying $950 on a $100,000 balance. Big, huge difference. 

Low-cost funds passively track broad market indexes. This means less work for fund managers. They just have to mimic the composition and returns of the indexes they track. And The Juice thinks most long-term investors can get everything they need — at least in their portfolio’s broad market core — going the low-cost route. 

An index is an index. If it’s the S&P 500 or something more specific and your fund manager is doing nothing other than passively tracking it, why pay even a few pennies more in management fees?

It makes no sense.

And it’s exactly why we went with the Vanguard Total World Stock ETF (VT) in the aforementioned edition of The Juice. However, the potential drawback of VT is that, as a “world stock” fund, it’s still super heavy on U.S. tech stocks and other North American names. Fine and dandy if you’d like more domestic exposure in your “international” ETF. But, if you want a pure international fund with no U.S. exposure, The Juice thinks you should buy the iShares Core MSCI Total International Stock ETF (IXUS). 

IXUS tracks a broad international index of non-US international stocks. So you get Taiwan Semiconductor (TSM) at the top of the holding list, not Nvidia (NVDA). And you get TSM at just 2.5% of the entire portfolio. The complete holding list is here. But it’s who’s who of international names across sectors. Nestle, not Procter & Gamble (PG). Novo Nordisk, not Pfizer (PFE). Just to name two more examples. 

And, to top it off, IXUS comes with an expense ratio of just 0.07%. 

The Bottom Line: We’re all for kicking the tires on ETFs that take a more active approach. However, don’t ignore the expense ratio. You have to ensure that the price you pay for active management isn’t so big that it offsets any enhanced performance. 

Case in point — also discussed in the alternative ETF link below — the CALF ETF. When our sister newsletter, The Spill, recommended it, they said: “While its 0.59% expense ratio is higher than some competitors, the unique strategy and strong performance justify the cost.” The Spill likes the approach CALF uses enough to feel as if it’s worth the higher expense ratio, at least relative to passive ETFs. 

As you form the core of your portfolio, start with only low-cost names such as SPY, QQQ, VOO, VT and IXUS. From there, you can stretch your legs and branch out into other worthy ETFs, such as CALF.

• What Are International Dividend Stocks And ETFs?
• Unlock Financial Clarity with The Juice
• What Are Alternative ETFs?
• Check Out The Juice’s Favorite ETF Screen