Watch out for transaction charges on ETFs

Exchange traded funds (ETFs) normally track indices that measure the progress of stockmarkets or specific sectors, and other asset classes such as property.

As there is no investment manager to pay, the costs of running ETFs are low. No trail commission is paid to advisers either.

Therefore, total expense ratios (TERs) tend to be modest - typically around 0.35% for UK-focused ETFs - while those focusing on foreign markets are higher, but generally less than 1%.

TERs on ETFs, like those of mainstream investment funds, do not include the cost of transactions within the funds, but turnover is lower because they are not actively managed so these costs are minimal.

Moreover, these and other costs can sometimes be offset by the revenue that promoters receive from lending their stock to other investors.

However, unlike with open-ended investment trusts and unit trusts, investors have to pay additional dealing charges when they buy and sell ETFs. Most stockbrokers charge the same to trade ETFs as they do for shares, so charges typically start at £10 to £15.

There is no stamp duty to pay, though. Any professional advice sought on which ETFs to buy also has to be paid for.

ETFs are not always the cheapest means of tracking the UK market even before these additional costs are taken into account. As the table above shows, some index-tracking investment funds also have low TERs. 

Although Vanguard's tracker funds are the cheapest option, they require a minimum investment of £100,000. However, they are also available on the Alliance Trust Savings platform, with a minimum investment of just £100.

The next cheapest are HSBC's tracker funds, which have TERs of 0.27%. HSBC cut its charges last September. It also offers American, European, Japanese and Pacific tracker funds with similarly low TERs and no initial charges.

This article was originally published in Money Observer - Moneywise's sister publication - in May 2010

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