Richard Evans

No Entry or Exit Fees: Another advantage of ETFs

Some critics of exchange-traded funds (ETFs) say you can get the same cost and tax advantages by using conventional index funds, especially at Vanguard. Long the king of index funds, Vanguard has about 24 of them, which they manage at extremely low cost. And I doubt there's anyone who can beat Gus Sauter at tracking an index closely while adding value.

But suppose you want to get into Vanguard's Small-Cap Growth, Small-Cap Value, or Emerging Markets funds. You have to pay a 0.50% entry fee on all purchases. Doesn't sound like much, especially compared with load funds charging 3 to 6 percent up front or later. But as Vanguard founder John C. Bogle loves to point out, costs matter. That up-front hit is leveraged by the growth rate of the fund.

(Editor's note - 4/15/2002: Not necessarily in response to this article, Vanguard eliminated purchase fees on four of its funds on April 12: Tax-Managed International, Tax-Managed Small-Cap, Small-Cap Value Index , and Small-Cap Growth Index.)

Entry and exit fees remain on many conventional funds in many fund families.

In contrast, you can get into, say, Dow Jones streetTRACKS Small-Cap Growth or Value ETFs with no entry fee, except for a roughly $10 commission at some of the Internet discount brokers. You can also get out at the same low price, a fact that takes on weight when you look at the redemption fee of many actively-managed funds.

Take the Royce Funds, for example. Chuck Royce is without a doubt one of the best small-cap managers out there; the long-term performance of his funds proves it. But most Royce funds carry a 1 percent redemption fee when you sell in less than 6 months, which I think is an issue in today's markets.

Unfortunately, some funds try to hug you even longer. Vanguard's Selected Value, Health Care, and Capital Opportunity funds make you wait 5 years before you can get out without paying a 1% redemption fee. And there are plenty of funds that charge more than 1 percent. Schneider Small Cap Value, for example, charges 1.75% on assets held for less than 12 months.

So, to the well-known advantages of ETFs, we can happily add no entry or exit fees charged by the fund.

Of course, there's always the argument that the vast majority of investors shouldn't be thinking in terms of less than 5 years. That has been a valid point for decades; I'm not sure it still applies. According to a study by Princeton professor Burton G. Malkiel and others, volatility in the markets has doubled in the last 10 years. And now we have to think about things like the looming retirement of 76-year-old Alan Greenspan and terrorist attacks, which could change everything. The case for using ETFs strikes me as stronger than ever.