One of the most compelling arguments for ETF investing is cost. The annual charge on a broad global equity ETF can be as low as 0.07–0.20% — a fraction of the 0.75–1.5% charged by a typical actively managed fund. Compounded over decades, this cost advantage is potentially enormous.
But the headline expense ratio is not the only cost of ETF ownership. Investors who focus solely on the ongoing charges figure (OCF) may be missing a significant portion of what they actually pay. Understanding the full cost structure — expense ratio, bid-ask spread, portfolio transaction costs, tracking difference, and tax drag — is essential for making genuinely informed comparisons between ETFs and for minimising the total drag on your returns.
This article breaks down each component of ETF costs and explains how to assess them.
The Ongoing Charges Figure (OCF)
The ongoing charges figure (OCF) — also called the total expense ratio (TER) or management expense ratio (MER) in different markets — is the annual cost of running the fund, expressed as a percentage of assets. It covers:
- Management fees paid to the index provider and ETF manager
- Administrative costs, custody fees, audit, legal, and regulatory costs
- Depositary fees
The OCF is deducted daily from the net asset value of the fund. If a fund has an OCF of 0.20%, that amount is taken proportionally from the fund's NAV throughout the year. It does not appear as a visible charge on your account — it is automatically reflected in the fund's performance.
OCFs for major UCITS ETFs range from:
- Ultra-low cost (0.03–0.10%): Largest UCITS providers' flagship equity and bond ETFs
- Standard (0.10–0.25%): Most broad equity and bond index ETFs
- Smart beta / factor (0.20–0.40%): Factor-tilted strategies with more complex rebalancing
- Thematic / specialist (0.40–0.65%): Clean energy, healthcare innovation, robotics and similar
- Emerging markets / frontier (0.20–0.55%): Higher costs for harder-to-replicate markets
The OCF is the most visible and most quoted cost, but it is not the whole story.
Tracking Difference: Better Than the OCF?
The tracking difference (TD) measures the actual performance gap between the ETF and its underlying index over a 12-month period, not just the stated costs. It is a more complete measure than the OCF because it captures all the things that cause the ETF to deviate from index performance.
The tracking difference can be better or worse than the OCF:
- If the ETF earns income from securities lending (lending out its holdings to short sellers and collecting a fee), this income can offset some or all of the OCF, producing a tracking difference smaller than the stated fee
- If the ETF incurs significant transaction costs when rebalancing — adding and removing stocks when the index changes composition — the tracking difference will be larger than the OCF
- If the ETF holds cash buffers to manage creations and redemptions, this cash drag produces a slightly worse tracking difference
- Dividend withholding tax paid on foreign dividends (see below) is a real cost that widens the tracking difference even though it is not reflected in the OCF
For an investor selecting between two ETFs tracking the same index, the 12-month tracking difference is often a more useful comparison than the OCF alone. A fund with an OCF of 0.20% but securities lending income that generates a tracking difference of 0.10% is cheaper in practice than a fund with an OCF of 0.15% and a tracking difference of 0.18%.
Tracking differences are published in ETF fact sheets and are tracked by independent data providers.
Bid-Ask Spreads: The Cost of Trading
ETFs trade on exchanges throughout the day. At any moment, there is a price at which you can buy (the ask price) and a slightly lower price at which you can sell (the bid price). The difference between them — the bid-ask spread — is a transaction cost paid each time you buy or sell.
For highly liquid ETFs — major UCITS ETFs on European exchanges with daily trading volumes in the tens of millions — the bid-ask spread is typically 0.01–0.05% of the ETF's price. This is negligible for long-term investors.
For less liquid ETFs — niche thematic ETFs, small-fund-size products, or ETFs trading in less liquid underlying markets — the spread may be 0.10–0.50% or more. This adds meaningfully to the round-trip cost of an investment.
Why spreads matter more than many investors realise:
If you invest £100,000 in an ETF with a 0.20% bid-ask spread and hold for 5 years, the round-trip cost (buying and selling) is £200, plus the same amount on exit — £400 total. For a £1 million investment, £4,000 total.
If you invest in an ETF with a 0.02% spread, the round-trip cost is £40 on a £100,000 investment.
The spread also compounds: investors who trade frequently — rebalancing quarterly, switching ETFs, taking tactical positions — incur the spread on each trade. Long-term buy-and-hold investors who rebalance annually minimise this cost.
Tips for managing bid-ask costs:
- Use limit orders rather than market orders for large transactions
- Trade during market hours, not in the early morning or late afternoon when spreads widen
- Avoid very thinly traded ETFs for large positions
- When buying a smaller ETF, consider placing the trade in stages over several days to avoid moving the price
Portfolio Transaction Costs (PTCs)
Inside every ETF, the fund manager buys and sells securities to track the index. These internal trades incur transaction costs — brokerage commissions, market impact, stamp duty on UK equities — that are not included in the OCF but are a real drag on the fund.
ETFs disclose portfolio transaction costs in their Key Information Documents (KIDs) or annual reports. For a simple large-cap equity ETF tracking the FTSE 100, PTCs might be negligible (0.01–0.02%) because the index rarely changes composition. For a high-turnover factor ETF or a small-cap index that turns over frequently, PTCs may be 0.10–0.30% per year.
Transaction costs inside the fund are distinct from the transaction costs you pay when buying or selling the ETF itself (the bid-ask spread).
Dividend Withholding Tax: A Hidden but Significant Cost
Governments impose withholding taxes on dividends paid to foreign investors. When a US company pays a dividend to a UCITS ETF domiciled in Ireland, the US government withholds 15% of the dividend under the US-Ireland tax treaty (rather than the 30% default withholding rate). This tax is a real economic cost to the fund — it is money that belongs to fund investors but is taken by foreign tax authorities.
For a fund tracking a globally diversified equity index with a dividend yield of around 1.8% and significant US exposure, withholding tax losses might amount to 0.10–0.25% annually, depending on the fund's treaty position.
This cost is not reflected in the OCF — it is captured in the tracking difference. This is one reason why Irish-domiciled UCITS ETFs are often preferred: Ireland's comprehensive tax treaty network (including a beneficial 15% treaty rate on US dividends) minimises withholding tax leakage compared to ETFs domiciled in jurisdictions with less favourable treaties.
UK-listed investment trusts and some UCITS bond ETFs face different dividend tax treatment, and the calculations vary by fund.
Tax Drag: When Tax Applies to You
Beyond the fund's internal costs, you pay personal taxes on investment gains and income. For international investors, the relevant tax depends on your country of residence and the tax treatment of the specific ETF.
Capital gains: When you sell an ETF at a profit, capital gains tax may apply. Rates vary: the UK applies 18–24% CGT on investment gains; Germany applies a 25% Abgeltungsteuer; UAE and most Gulf states have no capital gains tax at the personal level.
Income from distributing ETFs: If you hold a distributing ETF, dividend payments may be subject to income tax in your country of residence. For higher-rate taxpayers, choosing accumulating ETFs (where dividends are reinvested inside the fund) may reduce annual tax drag.
Excess reportable income on accumulating ETFs: UK resident investors must pay tax annually on the "excess reportable income" of accumulating offshore funds, even though no cash is received. This can be inconvenient but is not an additional cost beyond what would have been paid on a distributing ETF — it is a timing difference.
Stamp duty reserve tax: A specific exemption (in force since 2014) means that purchases of exchange-traded funds themselves do not attract the 0.5% SDRT that applies to ordinary UK shares — this applies regardless of where the ETF is listed or domiciled. By contrast, when you buy individual UK-incorporated company shares directly you do pay 0.5% SDRT. (Note that the underlying portfolio of a UK-equity ETF will still bear stamp duty on the fund's own purchases of UK shares, which is reflected in portfolio transaction costs rather than charged to you directly.)
The True All-In Cost: A Worked Example
Consider two ETFs tracking the same MSCI World Index, both UCITS-compliant and available to an international investor:
ETF A:
- OCF: 0.20%
- Tracking difference: 0.15% (securities lending income reduces it from the OCF)
- Bid-ask spread (round trip, one trade per year): 0.04%
- Portfolio transaction costs: 0.03%
- True annual cost to a buy-and-hold investor: ~0.22%
ETF B:
- OCF: 0.12%
- Tracking difference: 0.20% (higher transaction costs or less favourable dividend withholding position)
- Bid-ask spread (round trip): 0.08% (less liquid listing)
- Portfolio transaction costs: 0.05%
- True annual cost to a buy-and-hold investor: ~0.33%
On the OCF alone, ETF B appears cheaper. But on a total cost basis, ETF A is the better choice for a buy-and-hold investor making one transaction per year.
This illustrates why relying only on OCF is misleading.
How to Find ETF Cost Data
The following resources provide comprehensive ETF cost data:
- JustETF (justETF.com): Leading UCITS ETF comparison tool for European investors, includes OCF, tracking difference, fund size, and bid-ask data
- ETF.com: Comprehensive US ETF data
- Morningstar: Full ETF profiles including cost and performance data
- ETF provider fact sheets and KIDs: Compulsory EU documents include OCF and portfolio transaction costs
When comparing ETFs, look at the 12-month tracking difference rather than relying solely on the OCF for a complete cost picture.
Compliance Caveats
This article is for informational purposes and does not constitute personal financial or tax advice. ETF costs and tax treatment vary by jurisdiction and individual circumstances. All investments can fall in value as well as rise, and you may receive back less than you invest. Rules regarding stamp duty, withholding tax, and fund reporting status change over time — always verify current rules with a regulated adviser.
How Global Investments Can Help
At Global Investments, we conduct detailed cost analysis when constructing portfolios for internationally mobile clients. We compare ETFs on a total cost basis — not just headline charges — and select investment wrappers that minimise tax drag appropriate to each client's jurisdiction and circumstances. If you would like a review of your existing ETF holdings or help constructing a cost-optimised portfolio, contact us to arrange a consultation.
This article is for general information only and does not constitute financial, legal or tax advice. Rules, prices and regulations change; verify current requirements with a qualified adviser before acting.