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How do I calculate the cost of owning an ETF?

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Calculating the cost of owning an ETF involves considering several factors, including the expense ratio, trading commissions, and other potential fees. Here’s a step-by-step guide to help you estimate the total cost of owning an ETF:

1. Expense Ratio
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• Definition: The annual fee charged by the ETF provider, expressed as a percentage of your investment.
• Calculation:
  • Multiply the expense ratio by your total investment amount.
  • Example:
    • Investment amount: $10,000
    • Expense ratio: 0.20% (0.002)
    • Annual cost: $10,000 × 0.002 = $20

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2. Trading Commissions
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• Definition: Fees charged by your broker for buying or selling ETF shares.
• Calculation:
  • Add the commission fees for each trade (buying and selling).
  • Example:
    • Commission per trade: $10
    • Total trades: 2 (buy and sell)
    • Total trading cost: $10 × 2 = $20

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3. Bid-Ask Spread
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• Definition: The difference between the highest bid price and the lowest ask price.
• Calculation:
  • Estimate the spread as a percentage of the ETF price.
  • Multiply the spread percentage by the investment amount.
  • Example:
    • ETF price: $100
    • Bid-Ask spread: $0.05
    • Spread percentage: $0.05 / $100 = 0.05% (0.0005)
    • Cost on $10,000 investment: $10,000 × 0.0005 = $5

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4. Holding Period Adjustment
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• Definition: The cost of the expense ratio adjusted for the actual holding period.
• Calculation:
  • If holding for less than a year, prorate the expense ratio.
  • Example:
    • Holding period: 6 months
    • Adjusted cost: $20 (annual cost) × (6/12) = $10

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5. Total Cost Calculation
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• Definition: Sum of all costs over the investment period.
• Calculation:
  • Add up the expense ratio cost, trading commissions, and bid-ask spread.
  • Example:
    • Expense Ratio Cost: $20 (annual) or $10 (6 months)
    • Trading Commissions: $20
    • Bid-Ask Spread: $5
    • Total Cost (6 months): $10 + $20 + $5 = $35

Example: Full Calculation

Let’s calculate the total cost of owning an ETF with the following assumptions:

• Investment amount: $10,000
• Expense ratio: 0.20%
• Commission per trade: $10
• Bid-Ask spread: 0.05%
• Holding period: 6 months

Step-by-Step Calculation:
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1. Expense Ratio Cost:
   • Annual: $10,000 × 0.002 = $20
   • For 6 months: $20 × (6/12) = $10
2. Trading Commissions:
   • Total: $10 (buy) + $10 (sell) = $20
3. Bid-Ask Spread:
   • Spread cost: $10,000 × 0.0005 = $5
4. Total Cost:
   • $10 (Expense Ratio for 6 months) + $20 (Commissions) + $5 (Bid-Ask Spread) = $35

Additional Considerations
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1. Securities Lending Revenue Sharing:
   • Some ETFs offset costs by sharing revenue from securities lending, which may slightly reduce the effective expense ratio.
2. Taxes:
   • Consider potential capital gains taxes if the ETF is sold for a profit.
3. Dividend Reinvestment Fees:
   • If the ETF pays dividends and you opt for reinvestment, some brokers may charge a small fee.
4. Holding Beyond a Year:
   • If you hold the ETF for more than a year, multiply the expense ratio cost by the number of years.

Conclusion

​To calculate the total cost of owning an ETF, sum the expense ratio cost, trading commissions, and bid-ask spread, adjusted for the holding period. This gives you a clear estimate of the costs involved and helps in comparing ETFs for cost-efficiency.

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