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How to buy ETFs for less

A reader, C.H., writes in with an ETF query:

“Is it cost-effective to invest long-term in Exchange Traded Funds (ETFs)?”

C.H. explains he has decided upon a passive investing strategy but is dismayed by the feeble choice of index funds in the UK.

On the other hand, ETFs continue to spawn like Tribbles, filling every gap in the market from Azerbaijan to Vietnam.

C.H. is tempted to buy ETFs, but he is worried about ETF trading costs eating away his returns, as any investor should be.

The problem stems from the broker’s dealing fee, which takes a bite out of your investment every time you buy or sell an ETF (around £10 for an online trade).

At that price, a £100 per month investment would incur 10% in upfront costs every time – a ruinous penalty that flies in the face of low cost ETF investing.

But there are steps you can take to cut these costs:

  1. Get the best deal.
  2. Invest the largest sum you can per trade.
  3. Minimise the number of trades you make.
  4. Or avoid ETFs like a cost-riddled plague.

Three ways to reduce ETF trading costsLet’s look at each strategy for low cost ETF investing in turn.

1. Get the best deal for your ETF trades

Cheaper trading means using online brokers. There are tons out there, but the cheapest I’ve found yet for a single trade is X-O.co.uk.

X-O charges £5.95 and no ISA admin fee.

I don’t use X-O personally, but the Motley Fool broker board is a good place to go for word-of-mouth.

£5.95 is cheap, but you can do even better than that. You can slash costs to £1.50 per trade by using a regular investment service.

These services enable you to invest from £20 monthly in any ETF you like. The cost is low because you’ll trade on a set day that enables the broker to bundle up many small trades into one big trade.

I use TD Waterhouse’s regular investment ISA. Again, ISA admin cost is zilch, but the dividend reinvestment fees are cheaper than Interactive Investor for my portfolio size.

Both service providers allow you to skip some monthly contributions. You can also change which ETF you plan to buy at any time. Each service has its own little wrinkles, so it’s worth investigating both to get the best fit.

Takeaway: Research online brokers to get the cheapest deal.

2. Invest the largest sum you can each time

The larger your trade, the less impact the trading cost makes because it’s a fixed fee.

Think of trading costs as a percentage sliced off the sum invested. The table below shows how increasing your contribution size reduces this percentage loss:

    Sum invested (£) Trading cost (£) Sum lost (%)
    150 1.50 1
    300 1.50 0.5
    600 1.50 0.25

Use this charges impact calculator to see how cost-cutting saves you big bucks.

  • Scroll down to the investment calculator section to have a play (apologies there’s no direct link).
  • The longer you hold the fund, the more you can save by shaving costs.
  • Marginal cost reductions make less difference in pure £ terms when the contributions are small.

The calculator helps gauge whether you should bother sweating the difference. I aim for dealing costs of 0.5%.

Smaller costs are even better, while it would sting to pay over 1%.

Takeaway: Only trade when you’ve saved enough to invest to keep the costs down to a reasonable level.

3. Minimise trades

With ETFs, less is more:

Less drip-feeding
Less rebalancing
Less buying and selling
= more money saved

So save up your money and invest quarterly, semi-annually or annually.

Diversifying your portfolio slowly also helps. If instead of buying four ETFs in a year you buy only two, you instantly halve your trading costs.

The simplest passive investing portfolio contains only two funds – a total domestic stock market fund and total domestic bond market fund.

That’s a decent starting point for a small investor getting into low cost ETF investing. You can build up your position from that base, expanding into other assets at a later date.

You can also rebalance with new money to further cut costs, particularly in the early days of your portfolio.

Most rebalancing advice recommends you sell a portion of your outperforming funds and spend the money raised on topping up the laggards. But you can avoid the selling costs by instead moving back to your target allocations using just new contributions.

Later, when your portfolio is much larger than the new money you’re trickling in, you’ll probably need to reconsider selling holdings when you rebalance. But by then the frictional cost of trading these larger sums will be much diminished.

It also helps to restrict rebalancing to an annual event. Even then, you might only alter allocations when they have swung by more than 10% from target.

Don’t get too hung up on precise rebalancing. Rebalancing techniques are legion, but the evidence suggests that choosing any particular strategy makes marginal difference. The important thing is that you do it at all, so simply plump for a system that suits your style and needs.

Takeaway: Emphasise the ‘passive’ in passive investing.

4. Avoid ETFs altogether where possible

Do you really need ETFs, even though the stingy choice of UK index funds would embarrass a North Korean greengrocer?

Index funds are generally free of trading costs and the cheapest compare very favorably with ETF Total Expense Ratios (TERs).

The two-fund solution mentioned above can be done with UK index funds. And you can diversify some distance further before resorting to ETFs, too.

Track down index funds using this fund screener provided by the Investment Management Association (IMA). It’s the only fund screener I know of that sports an index fund filter. Just tick the tracker box.

Note, the IMA doesn’t list the super-cheap Vanguard index funds – that’s a whole new kettle of complicated fish that I’ll deal with another day.

You can compare index funds versus low cost ETFs by using a fund cost comparison calculator (scroll down to the investment section).

Treat the dealing cost as an initial charge. The TER goes in annual charge.

Takeaway: Only use ETFs where a viable index fund alternative does not exist.

Personally, I do employ ETFs as a long-term investment, but only to cover a few niche sectors. Index funds are simpler to handle and generally cheaper. If only there were more of them!

Take it steady,

The Accumulator

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{ 13 comments… add one }
  • 1 C.H. October 5, 2010, 11:13 am

    Wow, thanks for that – really appreciate the time you’ve taken on this!!

  • 2 Evan October 5, 2010, 7:20 pm

    There are certain companies on this side of the pond that don’t charge you trading fees if you purchase their ETF. I guess you don’t have any like that over there?
    .-= Evan on: The World’s Biggest Corporations that I Never Heard of =-.

  • 3 RetirementInvestingToday October 5, 2010, 10:01 pm

    Hi TA

    I also use TDWaterhouse for my ISA. Given the amounts I invest per trade and the small number of trades I make I’m happy with their total cost structure. The only important thing to remember is always trade online and not by telephone. Telephone charge is online charge+£30.

    Interesting you mention Vanguard. I’m exploring using Alliance Trust as a SIPP provider so that I can get access to Vanguard.
    .-= RetirementInvestingToday on: No nonsense FTSE 100 cyclically adjusted PE ratio update – October 2010 =-.

  • 4 The Accumulator October 6, 2010, 7:18 pm

    @ C.H. – It’s a pleasure. Hope you found it useful.

    @ RIT – I have an ISA through Alliance Trust so I can access Vanguard. They charge a dealing fee (£12.50 a throw, or £5 for regular investment) so you have to stick in quite hefty sums to reduce the cost. Aside from that, I haven’t experienced any problems so far. I enjoy your blog, btw.

  • 5 rhinestone October 6, 2010, 9:35 pm

    Great to see this series – I am in the process of building a portfolio precisely along the lines you are describing here – so very interested to see you thoughts on what funds to use to cover the various segments of the asset allocation mix.

    Looking to use Vanguard as part of this approach so picked up on your comments here – trade cost and restricted platforms are the only issues you are referring to here from the sounds of it.

  • 6 peter October 7, 2010, 4:49 pm

    Hi,
    nice article. I’m Irish and we have no cheap index funds, ISA schemes ect so I’m stuck with trying to find the cheapest broker to buy a broad based etf at regular intervals for the long term.
    There are a couple of pts bugging me, if anyone could shed any light I’d appreciate it.
    1) How do you treat the brokers expense wrt overall investment expense? If I plan to pick a broad based. Low cost etf and to periodically buy more of this etf over a time scale of some 30 yrs doesn’t the ter expense assume much more importance because of the power of compounding than the upfront brokerage expense?

    2) the cheapest efts I can find are the Vanguard etfs on the NYSE. A ter of .07 for the S&P 500. IF the plan is to add to this holding periodically over a period of say 25 yrs plus does the currency conversion issue become an irrelevance?

  • 7 The Accumulator October 8, 2010, 8:46 am

    @ Evan – no, we’re not as spoilt for choice as you are 😉 (I’m assuming you’re from the US.)

    @ Rhinestone – Those are definitely the headlines. The Vanguard situation in the UK will be the subject of my next post. Interestingly, they’re looking into introducing ETFs over here in the nearish future.

    @ Peter – Seems barmy that all those cheap funds are domiciled in Ireland yet Irish residents don’t benefit from them.

    1) I agree that over your time scale TER should be the most important cost. But trading costs can still hurt and it’s worth hammering them down where-ever you can, precisely because of the power of compounding. Play with the charges impact calculator to see the difference it makes.

    2) By currency conversion do you mean currency risk? i.e. the chance of the euro appreciating against the dollar and reducing your returns. This is a very hazy area. No one seems to able to provide a decisive answer. It could go for you, against you, work out broadly neutral – no-one knows.
    The simplest answer is to diversify. Have some holdings in your core currency, some in dollars, maybe even some in pounds!

    Judged solely on TER, US funds are the cheapest available to all of us. But there are other costs to watch out for. In the UK, for example, we get clobbered by withholding tax when investing in US-domiciled funds. I don’t know the details of the Irish-US tax relationship, but it’s definitely worth your while looking into.

  • 8 Cam July 26, 2011, 10:44 pm

    Nice artical. Good read. But I dont think you can buy EFT’s via regular investor on iii.co.uk or I have not been able to. It lets me buy at £10 a pop but not with the regular investor. Has anyone else been able to buy via iii.co.uk regular investor???? It could be because I am buying in pounds and the EFT’s are in Dollars? I might need to open an acount with TDWaterhouse but would it be ok buying in pounds??? Anyone…

  • 9 The Accumulator August 2, 2011, 9:19 pm

    Hi Cam,

    iii say you can invest in ETFs using their regular Portfolio Builder service: http://www.iii.co.uk/trading/share-dealing/how-do-i-invest/portfolio-builder

    I know for a fact you can with TD Waterhouse as that’s who I’m with. No problem buying in pounds.

  • 10 emanon August 12, 2013, 6:11 pm

    I notice you didn’t mention drip feeding cash into funds on a monthly basis (£1.50 with TD), don’t you stand a better chance at doing this in order to achieve a greater level of ‘averaging’?

  • 11 The Accumulator August 13, 2013, 7:12 am

    Hi, see point 1, paragraph 3. Regular investment at 1.50 with TD, iii and there is sippdeal too.

  • 12 robbieJ October 21, 2013, 2:38 pm

    Great website, so much useful information.

    Although, I don’t think your final point is quite true. I am investing 11k in a couple of Vanguard ETFs via Sippdeal for an isa (all bought in one go). Given that I would have to pay a custody fee if I went for the fund equivalent then it is cheaper to go the ETF route. Unless I am missing something?

  • 13 The Accumulator October 21, 2013, 10:29 pm

    Thanks, Robbie. The picture has got much more complicated since I wrote this post. Custody fees weren’t payable on funds back then. I wouldn’t like to generalise anymore, it depends too much on individual products, brokers and your buying patterns. Regardless, Vanguard ETFs via Sippdeal is a good choice.

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