S&P 500 ETFs and Index Funds: Are Fees All There Is to It?

Abstract

The expense ratio appears to be a key factor for investors in selecting between index-tracking exchange-traded funds (ETFs) and index funds. However, are fees all there is to it? Are ETFs “better” vehicles than their counterpart index funds in terms of fees as well as other performance/risk measures? The authors provide an in-depth analysis into other factors that may be pertinent to choosing between ETFs and index funds.

Since their inception in the mid-1970s, index-tracking mutual funds have attracted many cost-conscious investors. The introduction of the first ETF—the SPDR S&P 500 ETF Trust by State Street Bank and Trust Company, in the early 1990s—opened up a wide range of other options to these investors. In its January 5, 2011, issue, the Wall Street Journal reported a price war among index-tracking ETFs and mutual funds. The article cited that “Vanguard Group, BlackRock Inc., Charles Schwab Corp. and State Street Corp. are locked in a race to see who can cut expenses the fastest, vying for penny-pinching investors …” The article also pointed out that it could be misleading if investors simply compared expense ratios since additional costs could come in various forms (e.g., wide bid–ask spreads, commissions charged for buying and/or selling, etc.).

The Wall Street Journal article presents a common view among investors that the differentiating factor between index-tracking ETFs and index funds is expenses. However, should investors prefer one fund more than another because of fees only? Are there differences between ETFs (or between index funds) of different providers? This study aims to answer these questions by comparing and contrasting the cost, performance, and risk of two widely followed indextracking ETFs with those of two index funds.