Avoid High-Cost ETFs At All Costs

Let’s use a little common sense in today’s Juice. 

For a refresher, see our recent installment — What Is An ETF Expense Ratio?

Using the most straightforward, all else equal definition, an expense ratio covers the work fund managers do to run an ETF. Generally, the more work — and the more moving parts — the higher the expense ratio. 

Therefore, basic, broad market-tracking ETFs, such as SPDR S&P 500 ETF (SPY) and Invesco QQQ ETF (QQQ), tend to have lower — and, often, among the lowest — expense ratios. 

SPY’s expense ratio is 0.09%. QQQ’s is 0.20%. VOO, which is Vanguard’s S&P 500 Index tracking ETF, comes in even lower at 0.03%. 

Not long ago, The Juice warned against leveraged ETFs: 

A leveraged ETF uses debt or options to amplify the returns of a stock market index. 

Take, for example, #3 in today’s Trackstar list—the ProShares UltraPro QQQ (TQQQ). TQQQ  aims for daily investment results of three times the daily return of the Nasdaq-100 Index. Number four on the list—the ProShares UltraPro Short QQQ (SQQQ)—strives for daily investment results equal to three times the inverse of the daily return of the Nasdaq-100 Index.

The key word in that last paragraph is daily. On any given day, TQQQ and SQQQ will generate the exact same return as QQQ, but times three. If QQQ is down 1.93%, expect TQQQ to be down roughly 5.79% and SQQQ to be up by right around the same amount …

As a long-term investor, you might think if I’m bullish SPY or QQQ, why not buy an ETF that generates two or three times the performance? Because of the key word daily. The instruments used to achieve the amplifying effect function on a daily basis. They do not replicate long-term results. In fact, the typical holding period for a leveraged ETF, such as TQQQ or SQQQ, is one to two days. They’re meant for experienced traders and financial advisors (thus, their appearance in Trackstar, filtered to financial pros only), not new or long-term investors.

As was the case when we wrote that in September, TQQQ and SQQQ remain the third and fourth most-searched ETFs by financial advisors in Trackstar, our proprietary sentiment indicator. 

TQQQ’s expense ratio is 0.88%. SQQQ’s expense ratio is 0.95%. Both high. Because, here again, it takes more work to manage these ETFs. 

We have established that these ETFs aren’t suitable for most long-term investors. Not merely because of their relatively high expense ratios, but because of their goals and subsequent approach.

If you do enough research on ETFs — The Juice’s Favorite ETF Screener is a great place to start — you’ll likely come across some attractive-looking ETFs with super high expense ratios. To best illustrate our point, today we go extreme and consider the Invesco KBW High Dividend Yield Financial ETF (KBWD), which has a whopping expense ratio of 3.84%, among the highest in the entire ETF universe. 

You’ll pay a pretty penny of $3,840 if you have $100,000 invested in KBWD. 

KBWD invests in financial firms with relatively high dividend yields. So this includes quite a few real estate investment trusts (REITs), such as the ETF’s top holding, ARMOUR Residential REIT (ARR). If you need a primer on REITs, see What Is A REIT? 

Because of this approach KBWD yields roughly 11.6%. Therefore, it can be attractive to investors in search of income. As of December 2023, KBWD pays an annual dividend of $1.96. It pays out monthly. KBWD’s November distribution came in at $0.15 per share. 

So, let’s do some math. 

If you invested $10,000 in KBWD at the beginning of 2023, you’d have roughly 661 shares, based on the January 3rd share price of $15.13. As we write this, KBWD trades for $15.18. So, your principal, without factoring in monthly dividend reinvestment, would have increased to $10,034. 

It’s fair to say KBWD is flat on the year. 

Doing some rough, eyeball math, you would be receiving between $99 and $115 per month in income throughout 2023, based on your initial 661 share lot. Of course, you can keep that income or reinvest it. Doesn’t really make much of a difference for our illustration purposes. 

What does make a difference is that your $10,000 investment works out to a fee of $384, based on KBWD’s 3.84% expense ratio. We’ll estimate high and say you received $115 each month of the year so far in dividend payments and will collect the same this month. That’s $1,380 in income. 

Not too shabby. Take away the expense ratio and, we’ll call it even at $1,000. 

So, $1,000 of income on what is basically a flat investment. 

Had you taken your $10,000 and put it in SPY at the beginning of 2023, you would have secured just over 26 shares. As we write this, your principal investment in SPY, without factoring in quarterly dividend reinvestment, would be worth approximately $11,856 today. An increase of $1,856. You would be faced with an expense ratio of just $9. 

Need we say more? There’s no need. The dividend payments you’d get from SPY in 2023 on this investment — we figured them to be roughly $125 so far this year — are mere icing on the cake. 

Even if you’re thirsty for income, in this scenario we’ll take capital appreciation — and a low expense ratio — any day of the week. 

Plus, there are better income-driven ETFs out there with low expense ratios, such as one our sister newsletter, The Spill, gave a 10 out of 10 rating to last week:

Top of the list is JPMorgan Equity Premium Income ETF (JEPI), an actively managed ETF that pays a hefty 9.14% dividend yield.

While that sounds delicious, we’ve seen how strategies that deviate from core indexes don’t always outperform them.

So, is this one any different?

JP Morgan’s actively managed fund sells call options (covered calls) on U.S. large-cap companies. It attempts to improve performance by only selecting stocks with lower volatility and value characteristics …

JEPI is unique in that it achieves both performance and large dividend payments, which isn’t easy … 

However, its performance isn’t far off the S&P 500. And the ability to offer investors a choice between dividend income or capital appreciation through reinvestment is unique.

So, as far as unique large-cap ETFs go, we like this one for the additional flexibility it provides with relatively low fees.

JEPI’s expense ratio is just 0.35%. 

The Bottom Line: We went with an extreme example to make our point. But we did for a reason. 

When you search ETFs, filter out anything with an expense ratio higher than 0.50% (or thereabouts). Because you can find what you’re looking for alongside low fees across almost any scenario you should be getting yourself involved in as a long-term investor. 

Also, income isn’t the end all and be all. If the share price of an ETF — or stock for that matter — stagnates or sucks, even attractive dividend payments might not offset a flat or declining share price. Find a balance between the two without being on the hook for exorbitant fees there’s really no need to even consider paying.

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