Have you ever wondered how ETF Management Fees work? There is a management fee aspect, but those funds aren't regularly withdrawn from your bank account.
Are they paid when you make a purchase? Or when you sell?
Those looking for some financial voodoo will be quickly disappointed.
Unlike stock trading, where you pay fees on each trade either a percentage or a flat amount per buy or sell order. ETF’s aren’t structured the same way. While your provider might still be charging transaction fees, those aren’t included when looking at the Management Expense Ratio (MER) for an ETF.
The boring reality is that your management fees are paid out of the funds assets, which usually include a portion of cash. Those fees, usually paid monthly, are simply transferred out of the funds operating bank account directly to the administrators.
That’s the simple answer. Once a month, the fund pays the administrators their set percentage with the funds from the operating account.
How unglamorous. No withdrawals from your trading account. No pre-authorized debit. No bill in the mail. It’s all taken care of automatically on the back end.
But, If I Don’t Pay the Fees…?
By now you’re likely thinking that something doesn’t add up. You can buy once, hold forever, and never pay a fee? But there is literally an advertised fee.
I mean sure, it comes from the operating account. But that monthly payment has to come from someone, right?
And right you are. Those fees are actually baked into the advertised price that you see on the exchange. Any premium incurred by those fees will be reflected in the price of the ETF unit.
The cash to pay for those fees comes from the returns from the fund itself. Imagine you hold a unit of ETF ABC, which indexes to the S&P 500. Certain companies in the S&P 500 grouping will do very well, and others not so much. The ETF is designed to follow the performance of the index as a whole. As such, the fund is periodically rebalanced (remember, this is one of the tremendous benefits of ETFs).
During rebalancing some of the winners will be sold, crystalizing some of the upside from those winning investments. The proceeds of the sale goes into the operating fund, which then buys more shares of under-represented stocks.
But not all the proceeds are used for repurchasing, some of that cash is kept behind and paid out as management fees.
This creates a drain on the ETF’s returns, which is in turn reflected in the price that you pay. A lower return calls for a lower price.
Ultimately, you do pay for those fees through the price you pay (or receive when selling), and the returns of the ETF while you hold. Since those fees aren’t directly coming from your account the same way commission or transaction fees do, they can be easy to forget about. But make no mistake, they do exist, and you are paying for them.
ETF’s carry some excellent benefits for those who aren’t professional traders. I believe those benefits certainly outweigh the usually paltry costs. But nothing in this life comes free, which is why it is so important to know the management fee percentage on your chosen ETF.