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ETF Specialist

ETFs Are Not Always Cheaper

On an asset-weighted basis, institutional mutual fund share classes are lower than ETFs' in all but one Morningstar Category.

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Do exchange-traded funds or index mutual funds offer lower-cost exposure to similar indexes? It may be reasonable to expect ETFs to charge lower expense ratios than their index mutual fund counterparts. After all, ETF managers do not have to maintain accounts for individual investors like index mutual funds, which helps reduce their administrative expenses. In order to evaluate whether this structural advantage actually translates into lower costs, we matched ETFs and index mutual funds that track the same indexes within several Morningstar Categories and compared their annual report net expense ratios. While differences in expense ratios do not tell the whole story, they offer a good starting point, because they often represent the largest and most predictable component of the total cost of owning a fund.

We limited our data set to broad market-cap-weighted stock and bond indexes tracked by both ETFs and index mutual funds. This removes the vast majority of ETFs from our study because most track specialty indexes that are not available in a mutual fund format. We eliminated funds that were launched after Jan. 1, 2013, and grouped the remainder by Morningstar Category. Each category also had to include at least three index mutual funds and three ETFs as of April 2014 in order to remain in the sample.

Alex Bryan does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.