We've had discussions a number of times on the benefits of ETFs vs Funds for low cost indexing strategies - especially where the intention is to increase the amount invested over time using dollar cost averaging (DCA). I thought I would do up a simple spreadsheet to calculate the average annual costs associated with a number of different strategies to demonstrate the impact of brokerage / buy spread and of management expense ratios (MERs). I've used three funds: STW - SPDR S&P/ASX 200 Index Exchange Traded Fund VAS - Vanguard Australian Shares Index Exchange Traded Fund VAN0010AU - Vanguard Index Australian Shares Fund (unlisted managed fund) Costs associated with these funds: Management Expense Ratio (MER): STW: 0.285%pa VAS: 0.27%pa VAN0010AU: 0.75%pa for the first $50,000 0.50%pa for the next $50,000 0.35%pa for the balance over $100,000 Brokerage / Buy costs: VAN0010AU: 0.20% STW & VAS: I used the brokerage costs listed by Netwealth (mostly because of the original question I was answering which used Netwealth as an example): $17.99 per trade for transactions up to $5,000 $19.99 per trade for transactions above $5,000 up to $10,000 $26.99 per trade for transactions above $10,000 up to $25,000 0.11% per trade for transactions above $25,000 I've looked at two scenarios: A) an initial amount of $10,000 invested, and then an additional amount added monthly B) an initial amount of $10,000 invested, and then an additional amount added quarterly, with each quarterly investment equal to three months worth of the monthly investments in A) - ie. $100 each month = $300 each quarter I've calculated the brokerage / buy costs of each investment, and then added the monthly MER costs (annual MER divided by 12). I have NOT taken movements in investment values into account - I have assumed that all funds perform the same net of fees. Final costs are added up over a 3 year period, and then an annual average cost is calculated. Summary There is very little difference in cost between STW and VAS (assuming you use the same broker, brokerage will be the same, and MER is very similar) There is very little difference in cost between monthly and quarterly investment in VAN0010AU (buy costs are a fixed percentage of the amount invested, unlike brokerage for an ETF) For small monthly investments, the managed fund is cheaper than the ETFs until you get close to $2,000 per month being invested (due to high brokerage costs for ETFs) For quarterly investments, the ETFs start becoming cheaper once you pass $600 per quarter (brokerage becomes manageable and MER is much cheaper than the managed fund) Note that exactly which will be the cheaper option for your own situation depends on a number of factors: the initial amount invested the additional amounts invested the frequency of additional amounts the cost of brokerage ... so don't assume that these numbers I've provided here will necessarily apply to you.

Thank you so much Sim. This most definitely helps with deciding in which I place my first investment, considering the vast amount of variables and confusion that faces the young and first time investor. Hope this generates much discussion and helps a ton of investors. To help kick start some discussion .. are the bid/ask spreads of ETFs a major contribution to the total costs if contributing quarterly ? Are there any sites - such as your own - that provides information or the history of aggregate bid/ask spreads of various ETF's, more specifically of the funds listed above ? None seem to pop up in a search.

That's a good question - and not something I've really thought about until you mentioned it. I don't know if this data is regularly updated or published anywhere. I'd have to ask the ASX whether they can supply this type of detail. My understanding is that bid/ask spreads of an ETF is largely tied to the transaction volume and market depth of the underlying securities traded in the fund. Thus, for a broad index based fund such as STW, with high (and increasing) trading volumes - the bid/ask spread should be improving. Indeed, I found a document which looked at market quality indicators for the ASX which specifically looked at STW amongst other things. They commented: "The average bid-ask spread fell by 52%, from 14.34 basis points to 6.87 basis points, over the 2008 to 2009 period." Full document here: http://www.sfe.com.au/content/sfe/trading/market_quality_indicators_200912_december_2009.pdf So it was previously 0.14% and is now just under 0.07% as at the end of 2009. On a $500 transaction, 0.07% works out to be about 35 cents. Naturally this increases the effective costs of any ETF, especially if making regular transactions ... but not really by enough to change the outcome of my analysis by all that much.

Thanks Sim, for your charts and analysis. I have not seen anything like it to date. I see a rosy future for EFTs. I think they will become popular. Johny.

Thanks for the reply Sim, the average spreads are suprisingly lower than I thought. What about peoples thoughts on monthly, quarterly and half yearly contributions ? What intervals do you guys contribute to your funds ? Like one interval over the other ? Any reasons why ?

Contributions I contribute at least monthly to my 'portfolio' based on my current percentage diversification and emotional status.

Thanks so much for your calc Sim It clears some cobwebs among all the different dizzying options out there. My stockbroker left me (without telling me) and because I'm not the faintest familar with shares, I'm considering a simple index fund. Thanks again Sim!

I've calculated the brokerage / buy costs of each investment, and then added the monthly MER costs (annual MER divided by 12). I have NOT taken movements in investment values into account - I have assumed that all funds perform the same net of fees. Final costs are added up over a 3 year period, and then an annual average cost is calculated. Thanks Sim, [Warning - N00b post] This is a very helpful analysis - the first one I've seen anywhere. Most places I've looked just have fund managers sniffily dismissing ETFs as being too costly to DCA, but without putting up the numbers. An observation - it appears to me that in a rising market the ETF cost curve would drop more rapidly i.e. the cross-over occurs for lower regular investments (and vice versa). i.e. Ignoring the step functions for the moment, the basic form of the cost functions in your spreadsheet are: Total Fund Cost = MER * [Total Asset Base] + Transaction Cost (Edited for stupidity) If the only variable is the Total Asset Base (the contribution is fixed in this example) and it increases over time then the costs for both index fund and ETF will increase, but at lower rate for the ETF. Over the long term if we expect the index to increase then the slightly higher ROI of the ETF - even given the same performance vs the Index - would compound and the total cost would asymptotically approach the MER... ? I tried this half-assedly on your spreadsheet and it seemed to work OK, at least for my numbers. What do you think? Did I n00b it up? RB

Once the numbers become large enough, the brokerage/application cost becomes similar ... 0.2% for VAN and 0.11% for the ETFs (using the assumptions from the original post). For small amounts invested, the cost of additional investment is by far the largest portion of the overall expense ... which is why managed funds are cheaper in this scenario. However, as the total amount invested grows, so does the MER proportionally grow, and assuming the regular investment amount hasn't also grown at the same rate, then the MER costs will eventually outweigh the regular transaction costs by a large margin. Once the additional amount being invested is large enough, brokerage generally becomes a fixed percentage cost, making it much easier to compare between ETFs and funds - cost differential is merely the difference between the percentage brokerage cost for an ETF and the percentage application spread for a fund. Either way, the point still stands, once your investment is worth enough, these regular costs become a less and less significant part of the overall equation ... and hence the ongoing cost tends towards the MER. ... and yes, if you have two equally performing funds, then the one with the lower overall cost will see a higher ROI. That's pretty straight forward. The trick is that for an ETF with small amounts being invested, you need about 150 times your regular investment already invested before your MER only equals the cost of the transactions. So if you are adding $500 per month, you need somewhere around $75,000 already invested before the MER will even match the cost of the regular transactions (50/50 split in costs). Let's compare with VAN0010AU where the regular transaction costs are a fixed percentage of the amount being added. With $10,000 already invested and $500 being added each month, the regular contribution fees only add 7.5% to the overall cost over three years. Let's increase it to $100,000 invested and $1000 per month added - the regular contributions now only add 3% to the overall cost! So for our ETF, to get the monthly costs down to a small enough percentage of the overall cost ... let's say we want the regular transaction costs to be no more than 10% of the overall cost, then you need over $650,000 already invested!!! Of course, I have not included growth at all in these figures. If we assume a 1% monthly compound growth along with the regular investment (minus fees), then obviously the MER grows at a higher rate than before due to the increased value of the fund. Now, we need just over $52,000 before our three-year transaction costs on a $500 monthly investment roughly equal the management fees over the same period. To get to the point where our monthly fees on the $500 regular investments add less than 10% to our overall costs, we would still need $540,000 already invested!! The whole point is that ETFs are expensive to DCA with when compared to managed funds - and only if you have very large sums of money invested relative to the amount you are regularly investing will the costs of those regular transactions become insignificant. My recommendations for people just starting out or with smaller balances, is to use managed funds if they want to DCA small amounts ... or alternatively, don't invest monthly but rather pool your money until you have a larger amount to invest and add it quarterly or even less frequently. Of course that diminishes the value of DCA somewhat - but at least you can contain costs to a degree if you insist on using ETFs. If you make less frequent one-off transactions into ETFs, the costs are much more reasonable.

to the OP.. Firstly great post. I used your analysis to support my purchase of ~$15k of STW in quarterly intervals over the last year. The reason i chose STW over VAS was due to the smaller buy/sell spread on STW. However - I recently noticed that VAS has reduced their Management Expense Ratio to 0.15% https://www.vanguardinvestments.com.au/retail/ret/investments/etfdetailVASIFE.jsp Do you, and others on the forum, see VAS now being the superior choice to STW, even factoring in the higher volume of STW? regards dave

Mutual fund equivalent of VAS is: Retail https://api.vanguard.com/rs/gre/gls/stable/documents/8288/au Wholesale https://api.vanguard.com/rs/gre/gls/stable/documents/7640/au The retail managed fund and VAS ETF all invest in the underlying wholesale fund.

@austing thanks, based on the comments above regular investments in the longterm ETFs seems better or not much. If i plan to make regular contributions say quartely in an ETF hoping - 5 yrs can withdraw for education purposes is it better option or mutual fund

Approximately how much do you think you will be contributing each quarter? The calculations in the original post were done over 7 years ago and I don't know if the various fees have changed or how much brokerage costs these days ... but based on those original calculations (and taking the assumptions listed in that original post into account) - if you are investing under $600 per quarter, you'd be better off with the managed fund ... over $600 per quarter, the ETF becomes more cost effective. Note that the $600 figure I quote is based on the assumptions about brokerage fees, buy spreads and MERs, so if any of those have changed or are different (eg you have a cheaper or more expensive broker), the actual figure for where ETFs become cheaper than managed funds will be different.

Hi Simon, Thank you for your excellent post and sharing your calculations (nothing beats a good Excel worksheet). I have a lot of experience with property but very little in shares. Your discussion was by far the best I read. I have a follow-up question with regards to the other "cost", namely tax. Assuming a person in the 87-180K tax bracket, making small regular investments, holding long-term 15-20+ years, what would you say about tax when considering VAN0010AU and VAS. Thanks, Jay