Are ETFs cheaper than mutual funds? It's complicated.

It’s no secret that exchange trade funds have perceived cost and tax advantages over index mutual funds.

Since ETF managers do not have to maintain accounts for individual investors like index mutual funds, Morningstar says this helps reduce ETFs’ administrative expenses.

But does that correlate with a lower-cost exposure than index mutual funds? Not necessarily so, says a new research report from Morningstar released Wednesday.

“ETFs do not incur some of the administrative costs that their index mutual fund counterparts face, but they are not always cheaper,” write Morningstar analysts Alex Bryan and Michael Rawson in the report, “The Cost of Owning ETFs and Index Mutual Funds.”

Morningstar evaluated the cost comparison by matching ETFs and index mutual funds that track the same indexes within several Morningstar categories and comparing these funds’ reported net expense ratios, which “often represent the largest and most predictable component of the total cost of owning a fund.”

Morningstar limited its data set to broad market-cap-weighted stock and bond indexes tracked by both ETFs and index mutual funds and then examined the asset- and equal-weighted net expense ratios for each category of ETFs and index mutual funds, based on their 2013 annual reports.

Here’s what Morningstar found:

“We find that ETFs in most categories do not have lower asset-weighted average expense ratios than index mutual funds that track the same benchmarks,” write Bryan and Rawson. “The difference in the asset-weighted expense ratios between the two vehicles is small in most categories.”

According to Morningstar, only three of the 14 ETF categories had a lower asset-weighted expense ratio than their mutual fund counterparts, and ETFs looked more expensive in eight of the categories.

However, the equal-weighted expense ratios suggest that ETFs do offer substantial cost savings.

Bryan and Rawson explain this in their report, “Although ETFs carry lower equal-weighted expense ratios in most categories, the most expensive mutual funds do not attract significant assets. … As a result, comparing expense ratios on an equal-weighted basis paints an inaccurate picture of the average investor’s experience.”

Morningstar is quick to point out that there are other variables that affect the results of this analysis as well, such as whether Vanguard funds are included.

Because Vanguard prices its funds at cost, Morningstar says many of its index mutual funds are cheaper than ETFs from other providers.

“Vanguard’s funds skew the results in favor of index mutual funds because the firm prices its funds at cost and has a larger share of the index mutual fund market than the ETF market,” write Bryan and Rawson.

The duo found that Vanguard funds accounted for 80% of the assets in Morningstar’s index mutual fund sample and 32.3% of the assets in the ETF group.

When all Vanguard funds — which tend to be among the largest mutual funds in each category — are excluded from Morningstar’s analysis, ETFs look cheaper than their mutual fund counterparts in all but the foreign large-blend category. However, the asset-weighted difference in costs between the two vehicles in the large-blend category has become smaller over time, according to Morningstar.

“Vanguard is also the only firm that offers ETFs as a separate share class of its index mutual funds, which really puts these funds in a class of their own,” according to Bryan and Rawson.

According to Morningstar, the asset-weighted expense ratios for Vanguard’s ETFs are slightly lower than the corresponding values for its mutual funds.

Morningstar says expense ratios are not the only consideration and points to tracking performance, tax efficiency and trading costs as other influences affecting the total cost of ownership.

“While we examine the differences in cost between ETFs and index mutual funds in great detail, these differences are generally small on an asset-weighted basis,” Bryan and Rawson write. “There are plenty of low-cost ETFs and index mutual funds that track some of the most widely cited benchmarks.”

In conclusion, Bryan and Rawson find that there may be no simple answer.

“When equity index mutual funds and ETFs track the same benchmark at comparable expense ratios, ETFs may be the better option for taxable accounts,” the duo report. “The cost equation swings in index mutual funds’ favor as the frequency of transactions increases or their size decreases (assuming liquidity isn’t an issue). However, in many cases, the optimal vehicle is simply a matter of personal preference.”

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