The Real Costs of a Fund: TER, Tracking Difference, Spreads and Order Costs
Separate the costs inside a fund from the costs of buying and selling it, and use tracking difference to compare ETFs that follow the same index.
What you will learn
- What the total expense ratio (TER) includes and what it leaves out.
- How to calculate tracking difference and tracking error and why tracking difference is the better cost measure.
- How spreads, order fees and currency conversion add to your costs.
- How to compare two ETFs on the same index using a simple cost table.
Explanation
Broker fees in general were introduced in the trading course. Here we focus on the costs specific to funds. They fall into two groups: costs inside the fund (paid every year, reduce the NAV) and costs of trading the fund (paid when you buy or sell).
TER (total expense ratio), often shown as "ongoing charges", is the yearly management and administration cost in percent of fund assets. A TER of 0.20% means about €20 per year per €10,000 invested, deducted daily from the NAV; you never see a bill. TER does not include the fund's own trading costs when it buys and sells stocks (for example at index reviews), and it does not show income from securities lending. The key information document (KID) and your broker's cost information under the EU Markets in Financial Instruments Directive (MiFID II) show further cost figures; read them, but they are estimates.
Tracking difference (TD) is the fund's return minus the index return over a period, usually a calendar year: TD = fund return − index return. It captures everything: TER, internal trading costs, taxes withheld on dividends, securities-lending income and sampling effects. A TD of −0.15% means the fund lagged the index by 0.15 percentage points. A TD can be smaller than the TER, or even positive, if the fund earns lending income or receives favourable tax treatment. Because one year can be unusual, compare several years.
Tracking error (TE) is the standard deviation (a measure of how much values scatter around their average) of the return differences. It measures how steady the tracking is, not how expensive. A fund that lags the index by exactly 0.20% every year has a high cost but a tracking error of zero.
Trading costs for you:
- Order fee: a flat fee, a percentage, or a mix with a minimum. Savings plans often have their own fee.
- Spread: the difference between bid and ask. You pay roughly half the spread when you buy and half when you sell, compared with the mid price.
- Exchange and third-party fees, and currency conversion if you buy a unit traded in US dollars instead of a euro listing of the same fund.
For a long-term buy-and-hold investor, yearly fund costs usually matter more than a one-off order fee. For small, frequent purchases, the order fee can dominate.
Worked example
Hypothetical example: you buy €10,000 of a global equity ETF and sell it one year later. Assumptions: flat order fee €4.90 per trade, spread 0.10% of the mid price, TER 0.20%, price unchanged over the year. Taxes are excluded.
- Buying: order fee €4.90 + half spread €10,000 × 0.05% = €5.00. Subtotal €9.90.
- Selling: again €4.90 + €5.00 = €9.90.
- Fund costs: €10,000 × 0.20% = €20.00.
- Total ≈ €9.90 + €9.90 + €20.00 = €39.80, or about 0.40% of the amount in the first year. If you hold for 10 years, the trading part is paid only once, while the fund costs recur every year.
Comparing two ETFs on the same index (hypothetical yearly averages over 4 years):
| ETF | TER | Average TD | Lag on €20,000 per year |
|---|---|---|---|
| Fund A | 0.12% | −0.30% | €20,000 × 0.30% = €60 |
| Fund B | 0.20% | −0.05% | €20,000 × 0.05% = €10 |
Fund B has the higher TER but delivered the index return more closely. TD is the better guide, provided it is measured over several years.
Tracking error: Fund A's yearly differences were −0.15%, −0.10%, −0.25% and −0.05%. Mean = −0.1375%. Sample standard deviation ≈ 0.085 percentage points.
Common mistake
Practice activity
On paper: you invest €25,000 once. Your broker charges 0.25% per order (minimum €4.90). The spread is 0.20%. The ETF has a TER of 0.07%.
- Calculate the order fee and the half-spread cost of the purchase.
- Calculate one year of TER costs.
- Add them up. Which cost is largest in year one, and which one matters most over 20 years?
Show solution
1. Order fee: €25,000 × 0.25% = €62.50 (above the minimum). Half spread: €25,000 × 0.10% = €25.00.
2. TER: €25,000 × 0.07% = €17.50 per year.
3. Total year one: €62.50 + €25.00 + €17.50 = €105.00. The order fee is largest in year one; it is paid once. Over 20 years the TER recurs every year (about €350 at an unchanged value), so for long holding periods the recurring cost becomes more important, and it grows as the portfolio grows. A percentage order fee on large amounts is worth comparing with flat-fee brokers.
Limitations: we assume an unchanged value and ignore taxes and the fund's internal trading costs.
Key takeaways
- TER covers management and administration, not the fund's internal trading costs or lending income.
- Tracking difference (fund return − index return) is the best all-in cost measure; compare several years.
- Tracking error measures steadiness, not cost.
- Add your own costs: order fee, half the spread on each trade and any currency conversion.
Next step
Next, you will learn how combining assets that do not move together reduces portfolio risk.
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