Trying to understand what trading costs actually are in funds and ETFs

Question

I'm trying to understand what the trading costs are in ETFs and funds. Is the explanation below correct?

ETFs have trading costs because they trade almost like stocks, so you need to go through a broker to buy/sell shares, and brokers take a commission.

That means that the ETF's trading cost depend on the broker you use, no on the financial firm that manages the ETF to track its respective index. E.g. you could buy a Vanguard ETF through a broker that doesn't work in Vanguard. Thus, this fee has to do with the broker, not with the ETF itself, therefore you won't see it in the ETF's prospectus.

On the other hand, funds don't trade like stocks. Investors can buy fund's participations directly without the need for a broker, which discards brokers commissions. However, the fund in question could take a fee for this kind of operations, though this is not usual. In any case, this hypothetical fee is totally related with the fund, and you should be able to detect it in its prospectus.

Answer 1

In general you are correct. However, please consider some brokers do not charge transaction costs on some ETFs. So Vanguard typically does not charge for Vanguard ETFs, and Fidelity has a collection of ETFs that they do not charge transaction costs for and I am sure other brokers have similar arrangements.

So no, such things will not be found in the prospectus of ETFs as those transaction costs are dependent upon the relationship between the broker and investor. The transaction costs you will see defined in the prospectus is for the trading activities that the ETF participates in. As an example an option trading ETF will incur much higher transaction costs then one that is an index fund.

Mutual fund trading costs are very similar, they can be quite high some have a front or back end load as much as 5%. Those are not as popular anymore but 20 years ago they were very common, or if one uses a financial adviser.

Those products is what really created Vanguard. Jack Bogle created a series of low cost, mutual funds that were passively invested that beat the pants off of actively managed funds, more so when one considered fees.