Know what you’re getting into with ETFs

Q: Am I being cheated by ETFs?

A: Exchange-traded funds are billed as a great way for investors to save money on fees. That’s true. But they’re not free, and there are costs investors need to be aware of.

ETFs are a tool for investors to quickly build a diversified portfolio. ETFs trade like individual stocks, but when you buy an ETF, you’re actually buying a basket of a number of underlying securities. This saves money. At $10 a trade, you’d spend $5,000 just on trading commissions if you wanted to buy all the stocks in the Standard & Poor’s 500. But you can buy the SPDR S&P 500 ETF — own a piece of the 500 stocks — and only pay $10 (or less if you have a broker that offers commission-free ETF trading).

That’s not to say there aren’t any costs. ETFs carry annual expense ratios. These are often much lower than what traditional mutual funds charge. The SPDR S&P 500 charges 0.09% a year. Funds in the category charge 0.35%, Morningstar says.

There is another cost to ETFs investors need to be aware of. The price of the ETF can move higher than the value of the underlying securities. This is called a premium. But this cost, in reality, isn’t an issue if you stick with big ETFs. Most big ETFs don’t have a premium since the trading is efficient. SPDR S&P 500, for instance, hasn’t had a premium in years.