You get what you pay for.
For investors of zero-fee ETFs, the hidden cost could be large, according to one industry expert.
“There’s a big risk that investors could be pennywise, pound foolish,” Ben Johnson, director of global ETF research at Morningstar, said on CNBC’s “ETF Edge” on Monday. “They’re increasingly incurring costs that are less directly visible, less measurable in the form of opportunity costs.”
For example, he says an investor could be earning 0.01 percent on their cash balance in a financial account where that investment would be better served at 2.25 percent interest in an online savings account.
“There’s no such thing as free. If you’re getting something for free, odds are you’re subsidizing that by paying for something else, whether explicitly or implicitly,” added Johnson.
Zero-fee ETFs typically make money by lending stock to clients, selling other products, or offering lower interest on cash funds.
“There’s also a question of diminishing returns,” said Dave Nadig, managing director of ETF.com, on “ETF Edge” on Monday. “For a while they have a waiver for a year. The question you have to ask yourself, is that really better than the three basis points that you pay Vanguard for similar exposure? That’s $30 on an $100,000 portfolio every year. Most people spend that on pizza without even thinking about it.”
Cathie Wood, CEO and CIO of ARK Invest, says a higher price for expertise pays off over the long term. Her ARK innovation ETF (ARKK), which invests in stocks in disruptive industries such as DNA technologies and automation, has outperformed the broader market so far this year.
“What we believe is happening with these zero-fee funds is that they tend to be the broad-based indices. Easy to just mimic an index, it doesn’t cost very much to do that. A machine can do that,” Wood said on “ETF Edge” on Monday.
There lies the danger, though, as ETFs that simply capture the broad market move will shut investors out of the high-growth companies that offer higher returns, says Wood.
“We think they are filling up with value traps because of all the innovation that we’re researching,” Wood added. “We think that we’re at the beginning of the pendulum shift away from passive back to active as more and more people recognize this.”