Mutual Funds or Exchange-Traded Funds? Considering Costs

Because exchange-traded funds don't have to manage hundreds of customer accounts or staff call centers, they have lower overhead charges that translate into lower expense ratios. However, you will have to pay the bid-ask spread and may have to pay brokerage commissions to buy and sell ETF shares, and the costs of rapid—or even occasional—trading can more than offset the initial advantage of an ETF's lower expense ratio. For those reasons, an ETF may be the most cost-effective choice for those who use discount brokers (or brokers that offer free trading in certain ETFs), invest a large lump sum of money (rather than dollar cost average or reinvestment plans), and are willing to hold the investment for the long term. For buy and hold investors, the expense ratio becomes a bigger determinant of total cost over long periods of time because they are paid every year, whereas transactions costs are incurred only when trading.