We’ve previously looked at how you should buy index funds [1] not ETFs if you want to invest in the simplest products possible (and remember, there’s nothing wrong with simple [2]!)
Low-cost index funds also win hands down against ETFs if you make small, monthly investment contributions.
The decisive factor here is dealing fees.
Dealing fees are charged by online brokers every time you buy or sell an ETF. But they are not applicable to most index funds.
These dealing fees can gobble up a huge amount of a modest monthly contribution, and so torpedo returns in the long term [3]:
- You might expect to pay £10 in dealing charges on a trade – or at best £1.50 (on purchases) if you sign up to a regular investment scheme.
- £10 in fees would slice 20% off a £50 contribution. Deadly! It’s still an unacceptably high 3% in the case of the regular investment scheme.
- I wouldn’t contribute less than £300 on a monthly basis to an ETF in a regular investment scheme. This reduces the dealing charge to a manageable 0.5% of the investment.
For any small investor who wants to pay into a diversified portfolio [4] every month, it’s pretty easy to see how dealing fees make multiple ETF trades unaffordable.
On Expenses
The other major cost consideration is which kind of tracker has the best Total Expense Ratio [5] (TER)?
In the UK, the cheapest index fund [6] usually trumps the cheapest ETF on TER, at least when it comes to the broad market indices that passive investors paddle in.
If you do find an ETF with a lower TER than a rival index fund, then you can do a quick battle of the costs (including dealing fee) by using a Fund Cost Comparison Calculator [7].
Just scroll down to find the calculator and type in your dealing fee percentage in the initial charge box.
Next part: What about tracking error [8]?
Take it steady,
The Accumulator