💸 Expense Ratios

Expense ratios are the most visible cost of owning an ETF, but they’re often misunderstood. This page covers the mechanics of how fees work — from the daily deduction you never see to the hidden costs that don’t show up in the expense ratio at all. Whether you’re new to ETFs or an experienced trader optimizing your portfolio, understanding the full cost picture is essential.

What is an expense ratio?

An expense ratio is the annual fee charged by an ETF (or mutual fund), expressed as a percentage of the fund’s average net assets. It covers the costs of operating the fund.

What’s included in the expense ratio?

How is it calculated?

Per SEC Form N-1A requirements:

Expense Ratio = (Total Annual Fund Operating Expenses / Average Net Assets) × 100

For semi-annual reports, the expense ratio uses expenses from the most recent fiscal half-year, annualized.

Example: An ETF with $10 billion in assets and $15 million in annual operating expenses has an expense ratio of 0.15%.

How are expense ratios deducted?

This is where most investors get confused. The expense ratio is not deducted as a single annual fee. You’ll never see a line item on your brokerage statement showing “expense ratio charge.”

The daily accrual method

Expense ratios are deducted daily from the fund’s Net Asset Value (NAV):

Daily Expense = (Annual Expense Ratio ÷ 365) × Fund Assets

Concrete example

The daily amounts seem trivial. The annual amounts seem manageable. But as we’ll see, the compounding effect over decades is massive.

What are typical expense ratios?

Expense ratios vary dramatically by fund type. Here’s what to expect in 2024-2025:

By fund category

What’s “good” vs. “expensive”?

For broad market index ETFs tracking the S&P 500 or total market:

According to the Investment Company Institute (ICI) 2025 report, the asset-weighted average expense ratio for equity index ETFs dropped to 0.14% in 2024 — down 62% from 1996 levels.

The fee compression trend

The ETF industry has been in a fee war for over a decade:

• 79% of ETF assets are now in funds charging 0.25% or less
• The lowest 20% of ETFs by expense ratio captured 80% of U.S. flows over the past 5 years
• In the most recent year, the lowest-fee quintile attracted 97% of net flows

Yet paradoxically, new ETF launches in 2025 have record-high average fees of 0.65% — driven by complex strategies like leveraged products, crypto exposure, and active management.

What costs don’t show up in the expense ratio?

The expense ratio is just one component of the Total Cost of Ownership (TCO). Experienced traders know that hidden costs can sometimes exceed the stated expense ratio.

Bid-ask spread

The difference between the highest price a buyer will pay (bid) and the lowest price a seller will accept (ask). This is effectively a transaction cost paid to market makers.

When it matters most: Frequent traders pay the spread on every round trip. For a buy-and-hold investor, it’s a one-time cost.

Premium/discount to NAV

ETFs trade on exchanges at market prices that can differ from their actual Net Asset Value:

• Premium: Market price > NAV (you’re overpaying)
• Discount: Market price < NAV (you’re getting a deal)

For liquid ETFs, this is typically ±0.05%. But during volatility or for illiquid ETFs, premiums/discounts can widen significantly.

Tracking difference and tracking error

Tracking difference is the simple gap between ETF return and benchmark return. If the index returns 10% and your ETF returns 9.85%, the tracking difference is -0.15%.

Tracking error is the standard deviation of tracking differences over time — a measure of consistency.

What causes tracking difference?

Implementation costs (advanced)

Recent academic research (2024-2025) has highlighted hidden implementation frictions that don’t appear in any disclosure:

Research by Sammon & Shim (2025) found that switching from quarterly to annual rebalancing could add 25 basis points per year to returns for some funds.

How do expense ratios compound over time?

Here’s where small differences become massive. Fees don’t just reduce returns — they eliminate all future growth on the money paid in fees.

30-year impact analysis

Scenario: $100,000 investment, 10% annual gross return, 30 years

A 1% expense ratio costs you nearly a quarter of your wealth over 30 years.

Standard of living impact

Nobel laureate William Sharpe calculated that under plausible conditions, choosing low-cost investments could lead to a retirement standard of living that is more than 20% higher than comparable investors in high-cost investments.

When does expense ratio matter more than trading costs?

Vanguard research (2025) calculated the break-even point where expense ratio savings exceed bid-ask spread costs:

Takeaway: For anyone holding longer than a few weeks, expense ratio dominates total cost.

What is securities lending and how does it affect costs?

How securities lending works

ETFs can lend their portfolio securities to short sellers and other borrowers:

1. Borrower pays a fee to borrow securities
2. Borrower posts collateral (typically 102-105% of security value)
3. Revenue is split between the ETF and the lending agent
4. Net effect: Can offset expense ratio and improve returns

Revenue sharing examples

From BlackRock iShares filings (March 2025):

• Fund retains 82-85% of lending income (after thresholds)
• Minimum retention: 70% of total income

Real-world impact

In 2022, some niche thematic ETFs (crypto, cannabis, clean energy) earned securities lending revenue that was 524% of their net expense ratio.

Where to find this data: Check the fund’s annual report under “Securities Lending” or “Statement of Operations.”

What about fee waivers and zero-fee ETFs?

Temporary fee waivers

Some ETFs temporarily waive all or part of their fees, typically to:

• Attract assets during competitive launches
• Hit asset thresholds for economies of scale
• Promotional periods

Example: Fidelity Yield Enhanced Equity ETF (FYEE) charges 0.00% on the first $250 million in assets (through August 2026). Above $250M, the blended rate becomes 0.14%.

Zero-fee ETFs

Several zero-fee ETFs exist (primarily from BNY Mellon, SoFi):

Reality check: Zero-fee ETFs have struggled to attract significant assets. Distribution and platform access matter more than the last few basis points. Once fees drop below 0.10%, other factors (tracking, liquidity) become more important.

How do I compare expense ratios fairly?

Step 1: Compare within the same category

Do compare:

• VOO (0.03%) vs. IVV (0.03%) vs. SPY (0.09%) — all S&P 500 trackers
• Multiple active large-cap growth ETFs against each other

Step 2: Use Total Cost of Ownership

TCO = Expense Ratio + Trading Costs + Tracking Costs

Weight by your investment style:

Step 3: Check net vs. gross expense ratio

Fee waivers can expire. Always check:

• Waiver expiration date
• Gross expense ratio (future cost)
• Fund company’s history of extending waivers

Step 4: Look beyond the number

Two ETFs with identical expense ratios can have very different total costs:

• Tracking difference: Check 1-year, 3-year, 5-year performance vs. benchmark
• Bid-ask spread: Check average spread on your broker’s platform
• Securities lending: Some funds offset more expenses than others
• Capital gains distributions: Check historical distribution frequency

Quick reference

Expense ratio benchmarks (2024-2025)

The bottom line

Sources

Learn more about the contents of this page by reviewing these sources: