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Beyond Expense Ratios: Weighing Holding Costs With Trading Costs

What’s more expensive—holding a fund, or trading it? It depends. We walk you through the important factors to consider when determining the total cost of either holding your funds or trading them.

Articles by Adam Grealish
By Adam Grealish Director of Investing, Betterment Published Mar. 12, 2019
Published Mar. 12, 2019
7 min read
  • The cost to hold a fund comes from the expense ratio and tracking difference.

  • The costs to trade a fund are due to bid-ask spread and liquidity.

  • We’ll show you how to determine the total fund costs for either holding or trading, based on your trading frequency.

The total cost of a fund includes more than the expense ratio—there are costs associated with holding the fund and costs associated with trading it. Investors should balance these two sets of costs based on how long they hold for and their trading activity. An accurate measurement of total fund cost takes into account holding costs, trading costs, the amount of time you invest for, and how frequently you trade.

Holding vs Trading

Fees generally fall into two categories: costs associated with owning a fund, which investors incur annually from simply holding the fund, and costs associated with trading a fund, which investors owe any time they wish to buy or sell. Investors should consider all associated costs and balance these competing costs against one another.

Let’s review these costs and how to weigh them appropriately to determine the total cost of owning an Exchange-Traded Fund (ETF).

Cost to Hold

The costs associated with owning or holding a fund are costs paid by the investor who directly holds shares of a fund. These fees generally take place on an annual basis inside the fund. They are incurred regardless of any investor activity and are proportional to the amount of money that is invested in that fund.

Expense Ratio

The largest component of holding costs is generally the expense ratio. This is the fee charged by the fund company for managing the fund. These fees are assessed directly from the fund assets, so shareholders will see this cost show up in the form of lower overall returns.

Tracking Difference

The second cost is due to tracking difference, which is the difference between performance of the fund and performance of its benchmark index. Many ETFs are passive investment vehicles, which means they do not actively select stocks with the intention of beating the market. Instead, ETFs aim to closely track established stock and bond benchmark indexes. Funds generally try to minimize tracking difference, since their goal is to match the performance of the benchmark index.

A number of factors can influence tracking difference: securities lending, fund trading activity in the underlying securities, and deviations in weights between the fund and the benchmark index.

Tracking difference does not necessarily mean that the fund performs worse than the benchmark index. It could also cause a fund to perform better than its benchmark, which is particularly likely if the fund engages in securities lending. Each factor could contribute to tracking difference in either direction.

Cost to Trade

A fund can’t be held until it’s purchased. Investors are exposed to additional costs when buying or selling a fund—due to both bid-ask spread and liquidity.

Bid-Ask Spread

Bid-ask spread is the difference between the price at which you can buy a fund and the price at which you can sell the fund at any given time. Every time you buy or sell a fund, you generally have to cover some or all of the bid-ask spread in order to complete the transaction. The bid-ask spread isn’t a cost that is charged by a specific firm, and investors don’t know exactly what they are ahead of time. It’s just the cost of market friction.

Depending on how much interest there is in the fund and how frequently it’s traded, bid-ask spread can vary from 0.01% to over 1.0% of the fund’s price. The smaller the bid-ask spread, the less you have to pay up front to purchase a fund, and the fewer concessions you have to make when selling.


Liquidity, often measured by trading volume, is the amount of shares available for trading. Liquidity becomes particularly important when an investor wishes to buy or sell large dollar amounts of a particular security.

If you wish to buy more shares than what is available at a given price, the price is likely to go up, making it more expensive to complete the full purchase. However, if many shares are available, you can be less concerned about prices moving higher as you try to buy.

Liquidity is frequently measured by the average dollar value of trades that occur in a day, or Average Daily Volume (ADV). ADV gives investors a succinct measure of how many shares are traded on average—and helps investors gauge potential market impact.

Other Trading Costs to Consider


Fund loads are fees charged when buying (front-end load) or selling (back-end load) a mutual fund. Loads are charged as a percentage of the amount bought or sold. Loads are charged on mutual funds, but not ETFs.


Commissions are fees charged by your broker to execute the trade on your behalf. Commissions are generally charged per trade, or, based on the number of shares traded. Unlike all the previously mentioned costs, which are directly associated with the fund, commissions vary based on who is executing the trade. A discount broker will charge lower commissions than a full service broker, for example. At Betterment, we do not charge commission on individual trades. All commission costs are covered in our management fee.

Cost Summary

The below table summarizes different cost components across the the entire ETF industry. While expense ratio is one of the larger costs, others costs like bid-ask spread and tracking difference can also be considerable.

Summary of Cost Components in the ETF Industry


10% of ETFs

Median 50%

of ETFs

Most Expensive

90% of ETFs

Expense Ratio 0.13% 0.48% 0.95%
Bid-Ask Spread 0.04% 0.20% 0.72%
Tracking Difference -0.51% * 0.34% 2.11%

Data source:
FactSet. Data as of 1/1/2019. 2223 ETFs in evaluated universe.

* A negative number means outperformance, or a “negative fee.” Recall that tracking difference can be either positive or negative—some ETFs have outperformed their benchmark and have a negative tracking difference.

Putting it All Together

In many cases, the expense ratio will be the largest portion of total fund costs. But, what if an ETF has a very wide bid-ask spread and does not trade frequently? What if you want to trade a large amount of a fund with low liquidity?

In such cases, trading costs may be greater than the expense ratio and other holding costs. To weigh trading costs against holding costs, you must consider how often you plan to trade.

Imagine that you are considering buying a new condo and you have two choices. One condo has very high condo association fees, but is well connected to free public roads. The other condo has low association fees, but is situated on an island which requires you to pass over an expensive toll bridge every time you leave the neighborhood.

Either option might be appealing depending on how often you plan to leave the neighborhood. If you work in an adjacent town and need to pay the toll every day, it may actually be cheaper to live in the higher cost building. However, if you are a homebody who will rarely cross the bridge, the lower cost building will be cheaper.

A similar analogy can be made when considering total fund costs. Expense ratios and other costs for holding funds are similar to the condo association fee. They are assessed on an annual basis and are incurred simply for owning the fund. Trading costs are similar to the toll. They are incurred only when an investor wants to buy or sell a fund.

How frequently we leave our neighborhood and cross the toll bridge is similar to our example of how often we trade a fund. To accurately account for the total fund cost, you must take into account how often you plan to trade.

Balancing Holding and Trading Costs

A good model of total fund cost will accurately reflect your expected level of trading and scale trading cost accordingly. At Betterment, we account for trading costs by taking into account the expected turnover, or trading activity, of our customers. We’ll discuss how we do this in more detail below.

Turnover measures the frequency of trading as a percentage of the initial holding’s value. Turnover of 100% is equivalent to buying a new fund and completely liquidating that position in the course of a year.

For example, if you buy $10,000 of a fund and then sell $10,000 later in the year, the turnover in that position would be $10,000 ÷ $10,000 = 100%. If you only sold $5,000 of the fund, you would have turnover of $5,000 ÷ $10,000 = 50%.

Thinking back to the condo analogy, you can think of turnover as roughly equivalent to the annual number of bridge crossings.

Investment holding periods will also impact turnover. Short investment holding periods will increase turnover, while longer holding periods will decrease turnover. Holding fees are charged on an annual basis, however, trading costs are incurred whenever there is trading activity. Trading activity could be many times in a single year, or once over 30 years.

We take holding period into account when considering turnover. For buy-and-hold investments, we average the initial turnover to purchase the investment over the length of the investment horizon.

In the condo analogy, if you only have to pay the toll to get to the low-cost island condo once—and you plan on staying on the island for the next 30 years—then you might be willing to pay a relatively high toll. The best way to evaluate that toll would be to spread out, or amortize, the toll cost over the 30 years you plan to stay on the island. This is exactly how we treat turnover related to the buy-and-hold investing we do at Betterment.

Considering All Costs in the Right Proportion

As we have seen, total fund costs come from a number of different sources. These costs can be broadly categorized into costs to hold and costs to trade.

Costs to hold and costs to trade are incurred differently. Costs to hold are generally assessed annually, while costs to trade happen only when buying or selling. The more you trade, the more trading costs you will have and the more trading costs will matter in the total fund cost calculation.

At Betterment, we use annual amortized turnover to appropriately weight the costs of trading and the costs of holding a fund. This process provides a holistic assessment of fund costs and allows us to make better investment decisions for our customers.

Buy and hold with Betterment

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Original content by Betterment

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