A Guide To The 10 Cheapest ETFs

By Sweta Killa of Zacks.com

Monday, June 8, 2015 2:40 PM EDT

The global ETF industry is hugely popular and has rapidly been piling up assets in recent years. To be more specific, it took only about two decades to reach $1 trillion in AUM, 23 years to double and just 25 years to hit a record of over $3 trillion at the end of May 2015, as per ETFGI.

This is because ETFs are clearly preferred to mutual funds and hedge funds by virtue of their unique strategies, transparency, diversification benefits, enhanced tax competences, low turnover and low cost. In fact, low cost has been one of the biggest drivers for making the ETFs popular and enhancing their total returns.

While there are several types of cost associated with ETF like trading commissions, bid/ask spreads, premiums and discounts, and tracking error, expense ratios are paid extra attention by investors. This is especially true as ETFs with low expense ratios significantly outperform their expensive counterparts when other factors remain constant. This can be explained by the following example (see: all the ETFs with Low Expense Ratios here)

Consider two funds with expense ratios of 0.10% and 0.50% and invest $10,000 in both. Now, both funds have delivered the same annual returns of 10% in 10 years. The fund with an expense ratio of 0.10% will grow to $25,703 in 10 years while the same fund with 0.50% in expense ratio will grow by a lower amount of $24,782 in the same time frame. Further, the difference in total returns (after expenses) becomes more significant if we increase the holding period. The same funds with expense ratio of 0.10% and 0.50% when invested for 30 years would have a value of $169,797 and $152,203, respectively, after 30 years.

Keeping the importance of expense ratio in mind, we have highlighted the 10 cheapest ETFs for long-term investors:

iShares Treasury Floating Rate Bond ETF ((TFLO - ETF report)) – Expense ratio: 0.00%

This is the first floating rate Treasury bond ETF that hit the market in February 2014 and tracks the Barclays US Treasury Floating Rate Bond Index. The fund focuses on high quality securities fully backed by the government that do not pay a fixed rate to investors but have floating coupon rates that reset daily using the most recent 13-week Treasury Bill auction high rate plus a spread. As such, this fund is the most exciting pick for investors seeking protection from interest rates risk while looking for safe investments like U.S. Treasury bonds.

This is because the floating rate notes have far lower interest rate sensitivity than their fixed rate counterparts, making them ideal choices in rising interest environments. Though it is often overlooked by investors having AUM of $10 million and average daily volume of under 5,0000 shares, it is an ultra-cheap option in the ETF world with expense ratio of 0.00%. The fund is up 0.23% in the trailing one-year period (read: Worried About Higher Interest Rates? Buy These Four ETFs to Profit).

Schwab U.S. Broad Market ETF ((SCHB - ETF report)) – Expense ratio: 0.04%

This fund provides broad exposure to the U.S. equity market by tracking the Dow Jones U.S. Broad Stock Market Index and is the low cost choice in the equity ETF world, charging just 4 bps in annual fees. Holding 2,024 securities, the fund is widely diversified across sectors and securities. Information technology is the top sector accounting for less than 20% while Apple (AAPL - Analyst Report) is the top firm taking 3.3% share in basket. Large caps account for 73% of the assets while mid and small caps take the remainder. SCHB is one of the popular and liquid ETF with AUM of $5 billion and average daily volume of 535,000 shares. The product has delivered 10.2% returns over the one-year period.

Schwab U.S. Large-Cap ETF ((SCHX- ETF report)) – Expense ratio: 0.04%

This fund targets the large cap segment of the U.S. equity market by tracking the Dow Jones U.S. Large-Cap Total Stock Market Index and holds 760 securities in its basket. Here again, information technology is the top sector with less than 20% share while Apple is the top firm at 3.7%. Other firms do not hold more than 1.9% of total assets. With expense ratio of 0.04%, the fund has amassed $4.5 billion in its asset base and volume is solid at over 518,000 shares. While this is a large cap fund, mid and small caps take minor portions each in the basket. The fund has gained about 10.1% over the past one-year period.

Vanguard Total Stock Market ETF ((VTI - ETF report)) – Expense ratio: 0.05%

This ETF follows the CRSP US Total Market Index, holding a large basket of 3,814 securities. Each security holds no more than 3.2% of total assets while financials, technology, consumer services and health care make up for a nice sector mix in the portfolio. It is the largest and most popular fund with AUM of nearly $56.8 billion and average daily volume of nearly 3 million shares. It charges 5 bps in fees and expenses and has gained 10.2% over the past one year (read: 3 Excellent ETFs for a Low Cost Diversified Portfolio).

Vanguard S&P 500 ((VOO - ETF report)) – Expense ratio: 0.05%

This is another low-cost well-diversified large cap fund tracking the S&P 500 index. It holds 504 securities in its basket with each taking less than 4% share while sector-wise too, none accounts for more than 20% of assets. The fund has AUM of $32.5 billion and trades in heavy volume of 1.8 million shares per day on average. Expense ratio came in at 0.05%. The ETF returned about 10.1% in the same period.

Schwab U.S. Aggregate Bond ETF ((SCHZ - ETF report)) – Expense ratio: 0.05%

This product offers broad exposure to the bond market by tracking the Barclays Capital U.S. Aggregate Bond Index. Its offerings are stretched across the top-rated (BBB+ higher) wide variety of 2,402 bonds with U.S. Treasury accounting for 36.1% share, closely followed by Mortgage Pass-thru and U.S. corporate bonds with 29.2% and 21% share, respectively (read: 3 Bond ETFs to Consider in a Market Slump).

Average maturity of 7.14 years and effective duration of 5.16 years indicate lower interest rate risk and default risk. The fund has managed $1.6 billion in its asset base while sees volume of more than 209,000 shares. It charges 5 bps in annul fess and is up 2.02% over the trailing one-year period.

iShares Core S&P 500 ETF ((IVV - ETF report)) – Expense ratio: 0.07%

This is the second largest fund in the space with AUM of around $69.6 billion and tracks the S&P 500 index. Like VOO, it is well spread out across sectors and security. The fund trades in volume of about 4.1 million shares a day while charges 7 bps in fees and expenses. The ETF added about 10.1% in the same time frame.

Schwab U.S. Large-Cap Growth ETF ((SCHG - ETF report)) – Expense ratio: 0.07%

This is also a large cap centric fund but targets the growth segment, holding 402 stocks in its basket. It follows the Dow Jones U.S. Large-Cap Growth Total Stock Market Index and charges 0.07% in annual expense ratio. The fund has a large allocation of 7.5% in the top firm – Apple – while other firms do not hold more than 2.6% of total assets. The product is also heavy on information technology at 26.6% while consumer discretionary, health care, industrials and financials also get double-digit exposure each in the portfolio.

The product is rich in AUM of 2.1 billion and average daily volume of over 212,000 shares. It charges 7 bps in annual fees and has added about 14.7% in the same time frame.

Schwab U.S. Large-Cap Value ETF ((SCHV - ETF report)) – Expense ratio: 0.07%

This fund offers exposure to the value segment of the large cap equity market by tracking the Dow Jones U.S. Large-Cap Value Total Stock Market Index. In total, it holds 350 stocks with a well-diversified portfolio as none of the securities accounts for more than 3.7% of total assets. However, the product is slightly tilted toward financials at 22.6% while information technology, health care and consumer staples round off the next three spots.

SCHV has amassed assets worth $1.4 billion so far and trades in volume of around 170,000 shares a day on average. With a low expense ratio of 0.07%, the ETF has been able to deliver about 5.8% returns in the trailing one-year period.

Schwab U.S. TIPS ETF ((SCHP - ETF report)) – Expense ratio: 0.07%

Unlike the above products, this low cost fund provides exposure to a portfolio of Treasury securities designed to offer protection from the negative impact of inflation, while assuming exposure to interest rate risk. It follows the Barclays U.S. Treasury Inflation Protected Securities (TIPS) Index, holding a small basket of 48 securities. It focuses on top-rated government bonds with AAA credit ratings and none holding more than 5.5% share (read: TIPS ETFs Worth Buying as Inflation Rises?).

Average maturity of 8.8 years suggests minimal default risk while interest rate risk is high for the product with an effective duration of 8.0 years. The fund has managed assets of $705.1 million and trades in moderate volume of about 82,000 shares per day. It charges 7 bps in annual fees and is down 1.14% in the trailing one-year period.

Bottom Line

It seems that Charles Schwab is emerging as a new leader in the low cost ETF offerings, overtaking Vanguard. This is especially true as 6 out of the 10 cheapest ETFs mentioned above are from Charles Schwab. Investors should note that though Charles Schwab ETFs have lower expense ratios and no commission trading fees, explicit costs might be higher than Vanguard.

However, this might not be a major issue as depicted by total returns at SCHB which has an expense ratio of 0.04% against the expense ratio of 0.05% for VTI. Both have delivered almost similar returns in different periods.