Quote:
Originally Posted by RB
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
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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.
